We’ve already discussed how depreciation (cost recovery) can be used by a real estate investor to obtain a tax deduction on a residential real estate investment or commercial real estate investment (nonresidential). So let’s give an example of how depreciation would get calculated for the tax allowance on a real estate investment.
Example
You purchase a residential income property (let’s say, a six-unit apartment building) in January for the price of $400,000. You attribute $275,000 to the building (depreciable basis) and $125,000 to the land. Assuming you don’t sell the property we can calculate your depreciation for the first full year.
The depreciable basis is $275,000 and the useful life is 27.5 years (27.5 years for residential, 39.0 years for nonresidential). So let’s calculate your annual depreciation allowance.
- Depreciation Allowance (annual) = Depreciable Basis / Useful Life
- Depreciation Allowance (annual) = 275,000 / 27.5 = 10,000
Because the mid-month convention must be applied to the first month the property is placed into service (only one half month’s depreciation is allowed for the month the property is placed into service and one-half month for the month disposed), you must reduce your depreciation for the first year by one-half month. If 10,000 represents 12 months depreciation, than one month would equal $833.33 (10,000 / 12), and one half month would equal $416.67 (833.33 / 2). Okay, now we can calculate your first year’s depreciation allowance: $10,000 less 416.67 = $9,583.33.
