DEPRECIATION – ARE YOU TAKING EVERYTHING YOU CAN?

© Copyright 2001-2011  Landlord.com

By Bob Cain
www.rentalprop.com
Copyright 2000 Cain Publications, Inc., 
used by permission

You are probably costing yourself money. Most investment property owners divide the cost of real estate between land and building, then depreciate the building over 27.5 years in equal installments.

Not every part of your rental property is real estate. You have a host of other pieces of property that aren’t real estate, and those can be depreciated over a much shorter period of time. Plus, there is one provision of the tax law that allows you to deduct a huge portion and possibly the entire cost of some property you would normally depreciate in one year.

Look at the depreciation schedule below taken from Internal Revenue Service instructions.

• Refrigerators, ranges, dishwashers, carpeting, furniture – 5 years

• Land improvements (sidewalks, fences, landscaping shrubbery, septic systems, water pipes) – 15 years

• Computers and peripherals – 5 years

• Typewriters, adding machines, copiers – 5 years

• Automobiles and trucks under 13,000 lbs. – 5 years

• Office furniture (desks, chairs, file cabinets, etc.) – 7 years

• Residential rental property building – 27.5 years

• Non-residential rental property – 39 years

You are allowed by law to separate all of these pieces of property from the value of the building and depreciate them individually on IRS Form 4562. As we will see later, that can make or save you thousands of dollars a year on your taxes.

Section 179

This is a program that allows you to expense at least part of what would normally be a depreciable item. You can claim the section 179 deduction of up to $20,000 for the 2000 tax year on property you might otherwise depreciate for the cost of qualifying property acquired for use in the rental property business. At the same time you cannot claim the deduction for the cost of property you hold for the production of income, such as your rental property.

The requirements are:

• You must elect to expense the year you purchased the item or with an amended return for that year.

• You can deduct only on the basis of the amount of cash you paid. So if you trade in a truck for another truck, you can only deduct the amount of cash you paid or will pay, not the amount of the trade-in. With vehicles, note the special conditions below.

• It must be “tangible personal property,” which means not real property. Land and land improvements and other permanent structures and their components are real property. Swimming pools, paved parking areas, and fences are examples of land improvements. Those must be depreciated straight line according to the schedule above.

• The amount you deduct cannot exceed your taxable income.  You may not use section 179 expense method for:  property you hold for the production of income, such as rental houses, vending machines, coin-operated laundry, air conditioning or heating units, etc.

If the amount of the deduction for the section 179 expense is less than the cost of the item, you must deduct the remainder of the cost over the depreciable life.

Automobiles and trucks are a special case. While you can use the section 179 deduction for cars and trucks, the deduction is limited to $3,060 the first year, $5,000 the second year and $2,950 every year thereafter.

Here’s how much money these benefits can save or make you.

First, if you bought the building with appliances and such included, divide the purchase price of the property into real and personal property.

Second, break out the property improvements, such as paving, fences, landscaping, underground pipes, etc. Add those to your 15-year depreciable property.

Third, divide the remaining property into land and improvements and depreciate the improvements over 27.5 years.

Even when you divide the property between raw land and improvements, you may be cheating yourself. Too often rental property owners take the value the county tax assessor puts on the raw land as its value. Remember, the land has pipes running under it, both water and sewer, or a septic tank.

You can also establish the value of the land by the comparable sales method. Calculate what other lots of similar size sold for in the area. These would be lots without improvements, such as fences and outbuildings. If the dollar amount you come up with by doing that is in your favor, that is if it is less than the amount the county tax assessor figured, use it.

Calculating the value of the land yourself could end up making you a chunk of change on your taxes. Say, for example, that the county tax assessor says the value of the land under your apartment building is $100,000. However, after you do your own research, you discover that similar lots in the area are selling for $80,000. Now deduct the value of the pipes under the building. You calculate their value to be $5,000. In addition, let’s say the total cost of the property was $250,000.

Using the county tax assessor’s figures your depreciation would be $5454.00 per year. However, after your research you do much better.

The building value would be $170,000, creating an annual depreciation deduction of $6181.00, or an extra $728.00 per year in tax savings, just on the building. Now figure the deduction on the pipes underground. You calculated that they are worth $5,000. Since those are depreciated over 15 years, your additional depreciation would be $333.00. That brings you a total of $1061.00 extra in depreciation, just for a little research on your part.

One more calculation: suppose your new property has a fence surrounding it and is well landscaped. You calculate the value of the fence and landscaping to be $5,000. Since both the fencing and the landscaping is 15-year property, you can deduct $333 per year for that. That is a saving of $152 per year over depreciating it at 27.5 years.

If you replace appliances, carpeting, fencing, heating or air conditioning units, landscaping or any other piece of tangible property we have talked about, make sure you begin depreciating it in the year you put it in service and don’t add it to the basis of the real property.

With our profits becoming increasingly marginal because of higher taxes and government regulations, we need to take advantage all the monetary benefits we can. Surveying how we are taking depreciation, then using all the tax benefits that Congress has provided can make a big difference in our bottom lines. Any questions or concerns you have must be addressed to a tax professional. While all these deductions are your right, there are often specific rules that need to be followed to take them. Failure to follow them could lead to an IRS audit, or at least the need to file an amended return.

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Robert Cain is a nationally-recognized speaker and writer on property management and real estate issues. For a free sample copy of the Rental Property Reporter call 800-654-5456 or visit their web site at www.rentalprop.com.

Related articles:

http://www.landlord.com/home_office_deduction.htm

http://www.landlord.com/kill_death_tax.htm

http://www.landlord.com/tax_strategies.htm

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