Depreciation is an essential concept for rental property owners, as it allows them to recover the cost of wear and tear on their property or any asset used to generate income over time. This tax-saving strategy comes with specific rules and guidelines that must be followed.
What Properties Qualify for Depreciation?
Not every property can be depreciated. To qualify, a property must meet the following criteria:
- Ownership: You must own the property, even if it is under a mortgage.
- Income Use: The property must be used for rental or income-generating purposes.
- Useful Life: It should have a determinable useful life, meaning it wears out, decays, or loses value over time.
- Longevity: The property is expected to last more than one year. Short-term properties held for less than a year do not qualify.
What Properties Do Not Qualify for Depreciation?
Some assets cannot be depreciated, including:
- Land: Land itself doesn't wear out or get used up. However, certain improvements, like planting bushes or trees, might qualify if they can be destroyed when the house is replaced.
- Excepted Property: This includes items like:
- Property placed in service and removed in the same year.
- Equipment used to build improvements (depreciation for this is added to the basis of the improvements instead).
When Does Depreciation Start and End?
The timing of depreciation can be complex. It begins when the property is ready and available for its intended use, not necessarily when it starts being utilized or rented. For instance:
- If you purchase and install a dishwasher in January, you can begin depreciation in January, regardless of tenant use.
- If you repair a house and list it for rent in July, depreciation starts in July, even if a tenant doesn't move in until December.
Depreciation ends when:
- The full cost or basis of the property has been recovered through yearly deductions.
- The property is retired from service, whether through sale, conversion to personal use, abandonment, or destruction.
Converting Personal Property to Rental Property
Should you convert a personal property, such as a former home, into a rental, you can commence depreciation the day it's ready for rental use. For example, if you vacate your residence in July, make necessary repairs by August, and list it for rent in October, depreciation starts in October.
Depreciating Idle Property
Even if your property is temporarily vacant—such as during repairs—it remains part of your rental activity, allowing you to continue depreciation deductions.
While depreciation can be technical, it is a potent tool for reducing taxable rental income. If you have any uncertainties, consulting a tax professional can provide clarity and ensure accuracy.