Simple Rental Property Depreciation Examples.
Residential rental property is depreciated over 27.5 years. For investors in residential real estate this depreciation expense is a good thing as the annual depreciation amount is something of a phantom expense. Our properties go up year after year (on average) yet we get to deduct a certain amount of depreciation expense from our annual rental income as if the properties were being "used up". There are, however, some important details best shown by example.
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Example 1 - Bob buys a house as a rental and he closes in June, 2007. The house is already rented when he buys it. He pays $200,000 for the house and from the property tax records he ascertains that the lot is worth $25,000 which leaves $175,000 as the value of the house itself, minus the land. His first four years' depreciation, then, would look like this:
- 2007 - $3448 (2007 tax year filed April 15, 2008)
- 2008 - $6363
- 2009 - $6363
- 2010 - $6363
Depreciation started in June because that's when Bob closed on the property and it was already a rental (and he continued to rent it). The first year figure (and subsequent years) is calculated via a simple chart published by the IRS. Even without the chart the depreciation can be figured quickly as residential property rentals can only be depreciated via straight-line depreciation (the simplest form). This works out to 3.636% of the property value (less the land) each year except the first and last years, with those years being determined by what month the property was turned into a rental. (See also our easy depreciation calculator.)
Example 2 - Bob buys a house as a rental and he closes in June, 2007. This time the house is not rented but Bob immediately puts it up for rent. He finds a tenant in August. His first four years looks like this (assuming the same priced house):
- 2007 - $3448
- 2008 - $6363
- 2009 - $6363
- 2010 - $6363
This is exactly the same as example (1). The reason is that even though the house was empty when purchased Bob still is using it as a rental property. The fact that Bob doesn't have a tenant yet and won't until August makes no difference. Bob bought it and put it up for rent in June so his depreciation begins in June.
Example 3 - Bob buys a house as a rental and he closes in June, 2007. The house needs some repairs and some paint to get it rent ready. Bob gets this done in July and puts it up for rent August 1. He finds a tenant before the month is out and the tenant moves in on September 1. Bob's depreciation is as follows:
- 2007 - $2387
- 2008 - $6363
- 2009 - $6363
- 2010 - $6363
In this case Bob's depreciation starts in August (thus the lesser amount for the first year) because that is when the property became rent ready and Bob put it up for rent. Again, finding the tenant and when the tenant moved in is not that important. The focus is on when it was ready and available for rent. If Bob would have finished in July but for whatever reason not bothered to even try and get a tenant until September then his depreciation expense would have not started until September!
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All three of these examples make some common assumptions. First we're assuming Bob made no additions or improvements to the house as these would have added to his basis and changed the depreciation amounts. Secondly, we're treating the house as a whole and depreciating everything together instead of breaking out items that could be depreciated more quickly than the 27.5 years. This is described in detail in our cost segregation tutorial.
The remaining 24 years in these examples are nearly identical to years 2008 thru 2010 except for the last year which will have differing amounts based on the month originally purchased and put up for rent.
Lastly, in example (3) did Bob lose that roughly $1000 difference in first year depreciation? No, Bob would still get it but it's tacked on to the last year, approximately 28 years from now. Few people own their rentals that long, however. -back to tutorial index-
