Rental Property Depreciation: How It Works And Its Benefits to Medical Professionals

Property owners always seek ways to minimise their income tax bills and overall taxable income. Rental property depreciation can be a helpful tool in achieving this goal, enabling you to increase your return on investment in homes, apartments, condominiums, and other investment properties.

In real estate, rental property depreciation is a fundamental accounting principle that allows you to deduct the cost of a significant asset with a useful life of one year or more over an extended period. This phantom expense can reduce your tax burden, enabling you to move into a lower tax bracket or eliminate income tax bills altogether.

Depreciation is a practical means for investors to maximize their property gains while minimizing expenses. These tax advantages may significantly impact your decision to invest.

For medical professionals, property depreciation can provide a tax benefit by allowing them to deduct a portion of the cost of the property over a period of time, rather than all at once. This can help to lower their overall tax burden and increase their cash flow. Additionally, it can help to offset the cost of upgrading or replacing the property in the future. 

Case Study

rental property

Dr. John is a medical professional who owns several rental properties as a source of passive income. As tax season approaches, Dr. John is looking for ways to reduce his tax bill and maximise his return on investment. After consulting with a real estate tax specialist, Dr. John learns about rental property depreciation and how it can benefit him.

Challenges:

Dr. John’s primary challenge is to minimise his tax liability while generating significant rental income. As a busy medical professional, Dr. John does not have the time to keep up with tax laws and regulations. He is also unsure of the benefits of rental property depreciation and how it can be applied to his unique tax situation.

Solutions:

Dr. John consults with a real estate tax specialist who helps him understand the basics of rental property depreciation. The specialist explains how depreciation works, how it affects his tax liability, and how he can maximise his tax benefits through depreciation.

The specialist helps Dr. John determine the depreciation schedule for each of his rental properties based on their useful life, which can be up to 27.5 years for residential properties. By spreading out the cost of each property over its useful life, Dr. John can take advantage of a significant tax deduction each year.

Results:

By utilising rental property depreciation, Dr. John is able to maximise his tax benefits and significantly reduce his tax liability. For example, suppose Dr. John owns a rental property worth $300,000 with a depreciation schedule of 27.5 years. In that case, he can claim a deduction of $10,909 each year ($300,000/27.5 years). This deduction reduces his taxable rental income and lowers his overall tax bill.

Rental property depreciation can be a valuable tool for medical professionals who own rental properties as a source of passive income. By working with a real estate tax specialist, medical professionals like Dr. John can learn how to maximise their tax benefits and reduce their tax liability. In today’s economy, every dollar counts, and rental property depreciation can make a significant impact on the bottom line.

Determining Eligibility for Rental Property Depreciation: Who Qualifies?

If you’re a rental property owner, you may be wondering if you’re eligible for rental property depreciation. Here are the key requirements to meet before you can claim depreciation on your rental properties:

is the dependent eligible
  • Ownership – You must own the property, whether you have paid for it outright or are paying off the debt.
  • Use in Business – The property must be used in your business or as part of an income-producing activity. This could include renting out the property or using it as an office or storage space.
  • Useful Life – Your property must have a determinable useful life. This means that its value will decline or be depleted over time. Common examples include appliances, carpets, and buildings.
  • Length of Useful Life – The property must be expected to have a useful life that exceeds at least one year. This means that it cannot be a short-term asset that will be used up quickly.

Meeting these eligibility requirements can allow you to claim rental property depreciation and enjoy the associated tax benefits. However, it’s important to note that the specific rules and regulations regarding rental property depreciation can be complex and ever-changing. It’s wise to consult with a tax professional who can help you navigate these requirements and ensure that you are maximising your tax benefits while remaining in compliance with the law.

What should you do before claiming property depreciation?

  1. Make sure the property is eligible for depreciation

    Not all property is eligible for depreciation, so it’s important to check that the property you’re planning to depreciate qualifies. For example, land is not eligible for depreciation.
  2. Determine the cost basis

    You will need to determine the cost basis of the property, which is the original cost of the property plus any related expenses (e.g. closing costs, legal fees, etc.)
  3. Choose the appropriate depreciation method

    There are several different methods for calculating depreciation, including the Modified Accelerated Cost Recovery System (MACRS) and the straight-line method. You should choose the method that best suits your needs.
  4. Keep accurate records

    Accurate records are essential for claiming depreciation. You should keep detailed records of all transactions related to the property, including purchase price, expenses, and any improvements made to the property.
  5. Consult a tax professional

    Before claiming depreciation on your property, it’s a good idea to consult a tax professional. They can help you navigate the rules and regulations related to depreciation and ensure that you claim the correct amount.
  6. Understand the impact of depreciation on your property value

    Depreciation can affect the value of your property and it might not be the best option if you are planning to sell the property in the short term
  7. Understand the tax implications of your depreciation

    Depreciation can have tax implications, it is good to take that into consideration when planning your tax strategy.

Calculating Rental Property Depreciation: A Step-by-Step Guide

calculate rental property

Rental property depreciation is an essential tool for property owners looking to offset taxable income. Here’s a step-by-step guide on how to calculate rental property depreciation:

Step 1: Determine Your Cost Basis in the Building

Your cost basis in a rental property is the total capital expense of the property minus the value of the land on which it sits. However, only certain items, such as legal fees and any seller debts that you agreed to pay, qualify as a capital expense. Be aware that the costs of any improvements to the property are added in the year they are incurred to determine the adjusted cost basis.

Step 2: Calculate the Amount of Annual Depreciation

For residential buildings put into service since 1986, the Modified Accelerated Cost Recovery System (MACRS) is used to calculate annual depreciation amounts. Under MACRS, the General Depreciation System (GDS) applies straight line depreciation to both residential and commercial rental properties. Most taxpayers will use GDS, which offers a 27.5-year recovery period for residential rental properties and a 39-year recovery period for commercial rental properties.

However, taxpayers must use the Alternative Depreciation System (ADS) method if the property is used for a qualified business purpose only 50% or less of the year, has a tax-exempt use, is financed by tax-exempt bonds, or is used primarily for agricultural/farming purposes. Note that the 2017 Tax Cuts and Jobs Act shortened the recovery period for taxpayers using ADS from 40 years to 30 years.

Calculating rental property depreciation can be complex, and the specific rules and regulations can change. It’s best to work with a tax professional who can help you determine the best depreciation method for your rental property and ensure that you’re maximising your tax benefits while staying in compliance with the law.

Risks associated with property depreciation:

  • Audit risk

    Claiming property depreciation can increase the risk of an audit. The IRS may scrutinise depreciation deductions more closely, so it’s important to keep accurate records and ensure that the property is eligible for depreciation.
  • Complexity

    The rules and regulations surrounding property depreciation can be complex. There are different methods for calculating depreciation and different rules for different types of property. It’s important to understand the rules and regulations and consult with a tax professional to ensure that you are claiming the correct amount.
  • Over-Depreciation

    Taking too much depreciation in a year can result in a tax liability in the future, when the property is sold, this is known as depreciation recapture.
  • Impact on property value

    Depreciation can affect the value of your property and it might not be the best option if you are planning to sell the property in the short term.
  • Timing of repairs or replacement

    The depreciation schedule is based on the date of purchase, if the equipment or property needs repairs or replacement before the end of the depreciation schedule, the business may not be able to claim all the deductions for the asset.
  • Inflation

    Inflation can reduce the value of the depreciation deductions over time, as the cost of the asset is spread over a longer period, the deductions become less valuable in current dollars.

The Bottomline

Rental property depreciation is an effective means of reducing taxable income over time. Rather than being able to claim the entire depreciation amount in one fell swoop, depreciation allows investors to gradually write off the cost of their property over an extended period. The process of rental property depreciation can also help investors save money and increase their financial portfolios without having to pay for additional expenses.

If you are considering investing in real estate, it is worthwhile to learn more about rental property depreciation and other tax advantages that may be available to you. To gain more insights on this matter, you can speak or chat with one of BloomWealth Accountants today. They can provide you with expert advice on how to maximise your investment and tax savings.

Leave a comment