When does depreciation begin on a property?

[LibrarIan]

I've started reading about real estate investment out of curiosity. I haven't made any moves yet. I keep seeing the concept of depreciation brought up and how the IRS has determined your property will depreciate x amount per year over 27.5 years, etc. Cool.

Maybe this is a stupid question, but does the depreciation begin when the property is constructed and ready for use? Or does it begin when I buy it and it becomes ready for use? For example, a house that is, say, 100 years old (far exceeding 27.5 years) is purchased by me and made ready to rent out. I can take depreciation on this property for 27.5 years? And then the next person who owns it? And so on? Does a property ever stop being able to depreciate?

tl;dr: Is it 27.5 years one time from when the property is built, or 27.5 years each time the property changes investor hands?

[secondcor521]

I'm not sure, but I believe depreciation schedules begin when the property is placed into service (as either a business or a rental).  So that would either be the date you first advertise it as a rental, or perhaps the date of the first rental.

I haven't looked at the depreciation tables and rules for a while, but yes, I think that you can do straight-line 27.5 year depreciation on a typical rental property.  I'm fairly sure there are shorter depreciation periods for things like appliances.

And yes, the next person who owns the rental property could start depreciating it when they put it into service as their rental.  Two things to note about this, though:

1.  I think there may be some requirement that the expected useful life of a property is at least as long as the depreciation period.  A 127.5 year old house might not meet that standard.

2.  When you sell the property to the new owner, you may have to pay depreciation recapture taxes on the total of all the depreciation you took while you were an owner.  So in my brain, depreciating a rental property works a little bit like a traditional IRA.

A property would stop being depreciated by you at the end of the depreciation schedule, so if you owned the property for 40 years, the last 12 years or so you would not take depreciation.

[bacchi]

In case it's not obvious, and you probably already know this, but depreciation is only for improvements. You can have a shack on a 1 acre lot in Telluride and it might depreciate only $2000/year even though the property was bought for $6 million.

[LightStache]

It starts when the current owner places it in service, meaning the point at which they make it available to rent.

Since houses actually last way longer than 27.5 years and actually tend to appreciate in value, the IRS depreciation system is inconsistent with the accounting concept of depreciation. So you could actually have the same structure get completely depreciated multiple times over multiple owners. For advanced credit, read up on cost segregation.

Lesson learned from me though. If you use tax prep software, make sure to save all forms, including depreciation schedules. I neglected to do that and it irritated my accountants a few years after the fact. ;)

[Sibley]

Example:

You buy a house on March 1 for $100k. You decide to rent it out. It is rented starting April 1st. When you go to do your taxes, the depreciation will be (assuming straight line over 27.5 years) 100k / 27.5 = 3,636 annual depreciation. But since it's a partial year, you'll only take 9/12 of that amount since it actually was a rental starting April 1st, or 2,727 assuming I worked the calculator right. (Techically, I believe you start when you advertise for rental or are actually renting to someone, which ever is earlier. There is grey here, so as long as it's not unreasonable you're probably fine with either 3/1 or 4/1)

If the property is more than just the rental, ie you're renting out a smaller unit, then you would only depreciate a portion of the overall basis. If it's a duplex and the rental is 50%, then you'd depreciate just 50% of the 100k.

You can deduct the depreciation as an expense on the sch E for rentals. This is nice. However, when you eventually sell the building, you will be taxed on all the depreciation that you took, known as depreciation recapture. This is not nice. The IRS requires that rentals be depreciated, so you don't have an option.

If you have a building that is past its useful life, ie not inhabitable, then you can't depreciate it as a rental, because it can't be a rental. If you buy a building and spend a bunch of money to fix it up, therefore it's not past its useful life anymore, then the purchase price + the money to rehab it (some complexity here) = your basis, and that's the number you'll use to calculate deprecation.

If you do big things that are considered capitalizable, then you can add those to the depreciation schedule and start depreciating those. Things like you built a new garage, completely replaced the roof, etc. Not regular repairs or expected maintenance - this is the bigger stuff that extends or expands the useful life.

Do keep good records.

[Weathering]

Do keep in mind that depreciation happens whether you benefit from it or not. Meaning that if your taxes will not benefit from using the depreciation against business income then you will be taxed on depreciation recapture anyway when selling.

There are income limits on depreciation offsets.
Depreciation deductions can be carried forward to a year when they will benefit you.
There is a lot to know before assuming it will be beneficial to your unique situation.

My parents recently passed and their house was purchased by a recently retired CFO. His plan was to rent the house to his child (she was about 26 years old). He could fix it up, then depreciate it for his foreseeable lifetime (<27.5 years) and put it in his will for his daughter to receive it upon his death. Pretty shrewd move.

[LightStache]

His plan was to rent the house to his child (she was about 26 years old). He could fix it up, then depreciate it for his foreseeable lifetime (<27.5 years) and put it in his will for his daughter to receive it upon his death. Pretty shrewd move.

Is it? He's going to have to charge his daughter market-rate rent. Is the market rent less depreciation and other rental-only expenses (e.g. insurance and maintenance) going to be less than the deductible expenses of just owning it as a second home w/o charging rent?

I think the math works out the same as if he were to buy the house and rent it to a third party, so there's really no benefit of renting to the daughter unless you're charging below-market rent, which is just tax evasion.

If this strategy makes sense I'd propose it for my family, but I just don't see how the tax math works out.

[bacchi]

His plan was to rent the house to his child (she was about 26 years old). He could fix it up, then depreciate it for his foreseeable lifetime (<27.5 years) and put it in his will for his daughter to receive it upon his death. Pretty shrewd move.

Is it? He's going to have to charge his daughter market-rate rent. Is the market rent less depreciation and other rental-only expenses (e.g. insurance and maintenance) going to be less than the deductible expenses of just owning it as a second home w/o charging rent?

I think the math works out the same as if he were to buy the house and rent it to a third party, so there's really no benefit of renting to the daughter unless you're charging below-market rent, which is just tax evasion.

If this strategy makes sense I'd propose it for my family, but I just don't see how the tax math works out.

It really only works if the parent is already giving his daughter financial assistance. 1) Rent to daughter at market rent; 2) Gift daughter $16k/yr (x2).

[LightStache]

His plan was to rent the house to his child (she was about 26 years old). He could fix it up, then depreciate it for his foreseeable lifetime (<27.5 years) and put it in his will for his daughter to receive it upon his death. Pretty shrewd move.

Is it? He's going to have to charge his daughter market-rate rent. Is the market rent less depreciation and other rental-only expenses (e.g. insurance and maintenance) going to be less than the deductible expenses of just owning it as a second home w/o charging rent?

I think the math works out the same as if he were to buy the house and rent it to a third party, so there's really no benefit of renting to the daughter unless you're charging below-market rent, which is just tax evasion.

If this strategy makes sense I'd propose it for my family, but I just don't see how the tax math works out.

It really only works if the parent is already giving his daughter financial assistance. 1) Rent to daughter at market rent; 2) Gift daughter $16k/yr (x2).

How? For a simple example, let's say you buy a $500K house, $350K depreciable improvements, $30K/yr market rent, $18K first year interest, $5K/yr property tax, and $5K/yr other expenses.

If you gift daughter the $30K rent, you're going to take a net tax loss about $16K/yr, including depreciation.

If you instead own it as a second home and let your daughter live there, you can deduct the interest and property tax at $23K/yr.

Mortgage interest deduction and SALT limits could be a factor, of course, but those are set to revert in a few years.

Regardless of those deduction limits, you'd be FAR better off renting the property to a third person and gifting the daughter $30K/yr to use on her own mortgage.

[bacchi]

His plan was to rent the house to his child (she was about 26 years old). He could fix it up, then depreciate it for his foreseeable lifetime (<27.5 years) and put it in his will for his daughter to receive it upon his death. Pretty shrewd move.

Is it? He's going to have to charge his daughter market-rate rent. Is the market rent less depreciation and other rental-only expenses (e.g. insurance and maintenance) going to be less than the deductible expenses of just owning it as a second home w/o charging rent?

I think the math works out the same as if he were to buy the house and rent it to a third party, so there's really no benefit of renting to the daughter unless you're charging below-market rent, which is just tax evasion.

If this strategy makes sense I'd propose it for my family, but I just don't see how the tax math works out.

It really only works if the parent is already giving his daughter financial assistance. 1) Rent to daughter at market rent; 2) Gift daughter $16k/yr (x2).

How? For a simple example, let's say you buy a $500K house, $350K depreciable improvements, $30K/yr market rent, $18K first year interest, $5K/yr property tax, and $5K/yr other expenses.

If you gift daughter the $30K rent, you're going to take a net tax loss about $16K/yr, including depreciation.

If you instead own it as a second home and let your daughter live there, you can deduct the interest and property tax at $23K/yr.

Mortgage interest deduction and SALT limits could be a factor, of course, but those are set to revert in a few years.

Regardless of those deduction limits, you'd be FAR better off renting the property to a third person and gifting the daughter $30K/yr to use on her own mortgage.

Current cash flow re: daughter: -$30k <-- -$30k to daughter, who pays a landlord

----
Buy and rent to daughter:

Schedule E is $30k (rent) - $18k (interest) - $5k (prop tax) - $5k (maint) - $12.7k (depreciation) = -$10.7k

New cash flow re: daughter: -<$28k <-- -$30k to daughter + $30k from rent - $28k (IT and maint) = -$28k + Sch E loss if any


Renting to a third party yields exactly the same results but the daughter presumably gets a house that she wants right now. Even if the 26 yo daughter could qualify for a $500k mortgage, any repairs are tax deductible and the daughter would likely have some say on renovations and materials.

[LightStache]

Renting to a third party yields exactly the same results but the daughter presumably gets a house that she wants right now.

Yes, we agree.

[soulpatchmike]

I've started reading about real estate investment out of curiosity. I haven't made any moves yet. I keep seeing the concept of depreciation brought up and how the IRS has determined your property will depreciate x amount per year over 27.5 years, etc. Cool.

Maybe this is a stupid question, but does the depreciation begin when the property is constructed and ready for use? Or does it begin when I buy it and it becomes ready for use? For example, a house that is, say, 100 years old (far exceeding 27.5 years) is purchased by me and made ready to rent out. I can take depreciation on this property for 27.5 years? And then the next person who owns it? And so on? Does a property ever stop being able to depreciate?

tl;dr: Is it 27.5 years one time from when the property is built, or 27.5 years each time the property changes investor hands?

Depreciation has nothing to do with the age of a property or a reduction of value over time. It simply reduces the cost basis of your asset over time and provides a tax benefit during the time of ownership.   Today the IRS only allows 27.5 years for residential real estate.  The depreciation starts when you close on the property or the day that you start to market it for rent if changing its use.  Once you sell, you recapture the depreciation taken to reduce the cost basis at 25%.  It is a benefit during ownership, but is not free when you sell.