Rental Property Depreciation Calculator
Calculate the depreciation for a rental property or real estate using the straight line method and mid-month convention, as required by the IRS for rental property and real property.
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How to Calculate Rental Property Depreciation
When owning or managing a rental property, it’s important to know how to calculate rental property depreciation. Depreciation is an accounting strategy that makes it possible to distribute expenses (such as the cost of acquiring a rental property) over time.
While calculating rental property depreciation is fairly straightforward, there are a few unique nuances that rental property owners should keep in mind.
Most notably, as a result of regulations established by the IRS, rental property owners need to use a modified prorated formula that moves the depreciation entry to the middle of the month, rather than the beginning or end of the month.
They also have to plan to own the property for more than one year and can only depreciate the property itself, not the value or cost of the land.
Don’t worry. It’s not as complicated as it sounds. In this brief guide, we will help answer the questions you might have about calculating rental property depreciation.
What is Depreciation?
One thing that many people tend to overlook is that depreciation is a cost allocation strategy, rather than an accurate estimate of how an asset’s value has changed over time.
By calculating depreciation, the expense of an asset (including rental property) can be distributed over the course of that asset’s useful life, rather than being accrued all at once.
This is an important tool for investors, allowing them to deduct the costs of long term investments like rental properties from their taxes.
For rental property owners, depreciation calculations can be used not only for the property itself but also for any investment they’ve made in the property that has a limited useful life.
There are many different depreciation calculation strategies you might consider, but the most common is straight-line depreciation. This straightforward formula will evenly distribute the costs of acquiring an asset (cost basis) over its useful life.
The straight-line depreciation method results in a linear distribution of costs (instead of an exponential distribution), which makes it very easy to calculate, and all you need to know are the cost basis of the asset and the recovery period (useful life).
Straight-Line Depreciation Formula
The straight line depreciation formula for a full year is:
depreciation = cost basis / recovery period
So, if the cost basis were $500,000 and the recovery period was 10 years, the yearly depreciation value would be $50,000.
Depreciation for Rental Properties
As mentioned earlier, rental property owners will need to make a slight adjustment to their depreciation calculation because the IRS requires depreciation to be allocated in the middle of the month instead of at the end of the year.
They will also need to separate out the cost they paid for the property from the value of the land it’s on, if they also own the land.
Prorated First Month Depreciation Formula
The IRS requires that the depreciation for the first year be prorated for the number of months the property is in use. The straight line depreciation formula for a partial first year prorated for the number of months in use is:
1st year depreciation = (12 – months) + 0.5 / 12 × cost basis / recovery period
As you can see, the only part of this formula that is different from the standard straight-line depreciation method is the first part, which accounts for the monthly adjustment.
So, if you are the owner of a rental property, be sure you update your books at least once per month so that you can account for depreciation throughout the year.
Frequently Asked Questions
What can you depreciate besides your rental property?
You can only depreciate the building, not the land, of your rental property. But you can also depreciate major improvements over the lifetime of owning that property, for example, replacing the HVAC system.
Can you depreciate a rental property if you purchased it using a loan?
Yes, you can depreciate a rental property that you have a mortgage or loan on as long as you are the owner and it is in your name.
How much can you depreciate a rental property each year?
Typically, rental properties are depreciated over 27.5 years, and you can depreciate up to 3.636% each year. However, be sure to check with your accountant to ensure you are making the proper assumptions.
- Internal Revenue Service, Publication 527 (2020), Residential Rental Property, https://www.irs.gov/publications/p527