Property Management Blog

Understanding Rental Property Depreciation

Bob Preston - Thursday, September 13, 2018
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As president and broker of the top ranked property management company in North County San Diego, I come in contact with many prospective clients who are considering renting their home and hiring us as their property manager. They may have a property for rent in San Diego, Del Mar, Solana Beach, Encinitas, Carlsbad or anywhere along the North County coastal area. One of the common questions I get asked about investment properties and renting a home is “what are the tax benefits”? My typical answer always starts with, “I’m not a tax accountant or attorney, but …”  Now that we have that out of the way, there are several common write-offs which make owning a rental property an attractive investment.  But don’t take if from me, here is a link to a page on the IRS website which provides great summary information on the various deductions available to landlords: Rental Real Estate Income, Deductions and Recordkeeping

The referenced IRS page states that rental property expenses which can be deducted from your tax return include the following:  interest on the mortgage (new limits may apply), your state property taxes, operating expenses (paying a property manager, etc.), maintenance, and depreciation. Of all these categories, perhaps the most complicated and misunderstood is depreciation.

Residential rental properties are typically depreciated using the 27.5 “modified accelerated cost recovery system” (MACRS). In tax terms, this is known as the property’s depreciation schedule. What this means is that you depreciate the cost of the physical structure of the home, based on its value at time of purchase, over 27.5 years. One key point is that the current value is not the entire “market value” of the property because you cannot depreciate the land upon which the building sits. The IRS view is that land does not get old, wear out, or become outdated over time and therefore never wears out. Most property tax bills will break out the estimate attributable to the land vs. the building structure. Insurance works the same way since you are typically protecting the home, not the land from a disastrous event.

There is nothing better to demonstrate a point than a quick example. Let’s say you purchase a new home in North County San Diego for $750,000. Based on the appraisal and your insurance estimate you determine the land to be worth $500,000 and the physical structure of the rental property to be $250,000. Let’s further assume you immediately put $100,000 into the property as capital improvements such as a deck, room addition, etc. As a tax deduction, you can then claim $12,727 each year as deprecation ($350,000 / 27.5).

We hope you found this example interesting. Again, I’m not a tax advisor or tax attorney and there is no substitute for getting sound tax advice when it comes to filing with the IRS. I think you will agree, however, that despite recent tax law changes, owning rental property in San Diego County is still an outstanding investment and provides many tax advantages! We hope you will consider us as your property management company!

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