As stated in an earlier post, depreciation (or cost recovery) is an allowable tax deduction real estate investors should always take advantage of on rental investment properties that they own each year based on the asset’s useful life as specified in the tax code.

What is Useful Life?

For tax purposes, a property’s useful life (not to be confused with its physical life) varies according to one of two classifications created for income property: Residential property (where 80% or more of the gross income is derived from dwelling units; except for such dwelling units as motels and hotels which are classified as nonresidential by the tax code) is 27.5 years, and nonresidential property is 39.0 years. For example, the Depreciation Allowance (annual) for a duplex would equal Depreciable Basis divided by 27.5 years, and for an office building it would equal Depreciable Basis divided by 39.0 years.

How To Calculate

1. Determine the depreciable basis by separating the value of the improvements from the value of the land. For example, assume you purchase a rental property for $300,000 and attribute $210,000 to the building and $90,000 to the land. The depreciable basis would be $210,000.
2. Determine the useful life according to the current tax code. (It will be either 27.5 years or 39.0 years depending on your property’s classification).
3. Apply the formula. For example, let’s assume the property you purchased for $300,000 is a duplex. The formula would be: Depreciation Allowance (annual) = Depreciable Basis / Useful Life. Or, Depreciation Allowance (annual) = $210,000 / 27.5 = $7,636.36.

Of course there are other considerations to factor in like the month you place the property in service and mid-month convention, but we’ll discuss that in the next publication. So stay tuned. In the meantime, you might want to preview some reports at the ProAPOD website where depreciation has been computed (go to the website and follow Reports).

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