In order to calculate investment property depreciation, it is important to know the useful life classification for that property. Depreciation is a measurement of the decline in value of an asset over time due to use or deterioration. For tax purposes, the useful life for assets may be found in depreciation schedules printed by governmental taxing authorities. In the United States, this authority is the Internal Revenue Service (IRS).
Calculating investment property depreciation allows a tax advantage that the property investor may claim against his or her investment income. The actual amount that can be claimed will depend on the amount paid for the property, the type of property, and the method of depreciation used. An investor cannot deduct the entire cost of the property in the year of purchase. Since the property will be useful over several years, and therefore producing income over time, the cost is spread out over that same period of time.
In the United States, most business depreciation is computed using the Modified Accelerated Cost Recovery System, also known as MACRS. The IRS provides information concerning a property’s recovery class and recovery period, or useful life, and allowable depreciation methods. Residential rental property and commercial structures are two main depreciation classifications. Investment property depreciation periods for residential rental property are 27.5 years, and the period for commercial buildings is 39 years.
Under the MACRS system, the only depreciation method that can be used for either residential rental property or commercial buildings is straight-line depreciation. This means that the total allowable investment property depreciation, or investment cost, will be divided equally over the taxable life of the asset. The basis or amount invested in the asset is the cost of the investment property plus settlement fees, such as abstract fees, recording fees, and title insurance.
Property must be used in a business or income-producing activity in order for depreciation to be allowed. As investment property depreciation is claimed each year, the basis, or value, of the asset decreases by the amount of yearly allowable depreciation. This is true each year of the asset’s life, whether or not the taxpayer actually claims the full amount allowed.
When computing investment property depreciation, only the investment cost applicable to the buildings can be depreciated, and not the cost of the land upon which the buildings are located. Land cannot be depreciated because it does not get used up or wear out as structures or other assets do. However, land preparation costs, such as landscaping, can be depreciated if they are associated with depreciable property and a life for them can be determined.