Rental Property Depreciation Isn’t Optional

Tip of the Week



Hello, Derek Merkler, the military financial advisor here with this week’s tip of the week.  The topic for this video is a trend I’m seeing amongst veterans who own rental properties.  If you are watching this video, you may or may not own a rental property, but you likely know that a common investment strategy for military veterans is to buy homes at each duty station to which they are assigned over the course of their career and then rent out those homes when they move to a new duty station.

I’ve noticed, more often than not, that rental property owners don’t depreciate their rental properties on their tax returns.  As a result, these veterans can be missing out on one of the better benefits of rental real estate which is the tax advantages. Depreciation is one of those tax advantages.

Depreciation, in this case, is a tax term where you reduce the cost basis of your rental property over your period of ownership and receive a tax deduction for that amount each year.

Now, there are a lot of caveats and technical details to depreciation, but I’ll offer a quick example. Depreciation for a single-family home occurs over a 27.5 year period meaning that the annual deduction from your taxable income would be 3.63% of the rental property’s cost basis.  So let’s say you paid $200,000 for the hom.  Annual deprecation would be $7,260.  That’s a big tax deduction to completely ignore.

The catch is that your cost basis or tax basis falls with depreciation and, should you sell the property in the future, those depreciation amounts are subject to something called depreciation recapture.  So your $200,000 house now has a cost basis of $150,000 after some years of depreciation and you sell it for $250,000.  As a result, your taxable gain is $100,000. Not just the $50,000 above and beyond the price you paid to purchase the house.

With that in mind, some people think that they won’t depreciate their rental property each year and, as a result, won’t have to pay those higher taxes when they sell.  This belief is incorrect.  You can fail to depreciate the property each year, but the IRS doesn’t care.  When you sell the property, the IRS will expect you to pay taxes based on the depreciation adjusted cost basis.  In that scenario, you get the worst of everything… no tax deduction during your ownership AND higher taxes when you sell.

So… do you own rental properties?  You may want to check your tax returns for depreciation deductions.

Thanks for watching! If you want more help on this topic, you know how to reach me.  Until next time!




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