How Rental Property Depreciation Works
Investing in rental property can prove to be a smart financial move. For starters, a rental property can provide a steady source of income while you build equity and the property (ideally) appreciates. There are also tax benefits: You can deduct your rental expenses from any rental income you earn, thereby lowering your tax liability. Most rental-property expenses – including mortgage insurance, property taxes, repair and maintenance expenses, home office expenses, insurance, professional services and travel expenses related to management – are deducted in the year you spend the money. For additional details, see Tax Deductions For Rental Property Owners.
However, another key tax deduction – the one for depreciation – works differently. Depreciation is the process used to deduct the costs of buying and improving a rental property (for a quick primer, check out An Introduction to Depreciation). Rather than taking one large deduction in the year you purchase (or improve) the property, depreciation distributes the deduction across the useful life of the property. The IRS has very specific rules regarding depreciation, and if you own rental property, it’s important to understand how the process works.
Which Property is Depreciable?
According to the IRS, you can depreciate a rental property if it meets all of these requirements:
You own the property (you are considered the owner even if the property is subject to a debt).
You use the property in your business or as income-producing activity.
The property has a determinable useful life (meaning it is something that wears out, decays, gets used up, becomes obsolete or loses its value from natural causes).
The property is expected to last more than one year.
Even if the property meets all the above requirements, it cannot be depreciated if it was placed in service and disposed of (or no longer used for business use) in the same year. Because land does not wear out, decay or get used up, it is not depreciable. And, in general, you cannot depreciate the costs of clearing, planting and landscaping, since those activities are considered part of the cost of the land.
When Does Depreciation Begin and End?
You can begin taking depreciation deductions as soon as the property is "placed in service" or ready and available to use as a rental. Here’s an example: You purchase a rental property on May 15. After working on the house for several months, you have it ready to rent on July 15, so you begin to advertise online and in the local papers. You find a tenant, and his lease begins on September 1. Since the house was placed in service (that is, ready to be leased and occupied) on July 15, you would begin to depreciate the house in July (not in September when you start to collect rent).
You continue depreciating the property until either
you have deducted your entire cost or other basis in the property, or
you retire the property from service, even if you have not fully recovered its cost or other basis. A property is retired from service when it is no longer used as an income-producing property – or if you sell or exchange it, convert it to personal use, abandon it, or it is destroyed.
You can continue to claim a deduction for depreciation for property that is temporarily "idle", or not in use. If you make repairs after one tenant moves out, for example, you can still depreciate the property while you get it ready for the next tenant. Via investopedia
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