Real Estate Depreciation ~ an Introduction

(The Other Best Reason to Own Real Estate)

What is depreciation? Why is it important? Depreciation is a deduction percentage allowed in income tax returns, to recover the cost of property. Not all properties qualify for depreciation. The annual allowance is allowed for compensating deterioration, wear and tear and obsolescence of the property.

Almost all tangible properties like machinery, vehicles, buildings, furniture and even equipment, intangible properties like patents, computer software and copyrights, etc are all depreciable. However, land does not qualify for depreciation, though the buildings constructed on it, can qualify.

Commercial property is eligible for 39 years of depreciation, under straight line method, where the depreciation value remains constant over the years.

Listed below, are the qualification criteria to be met for a property to qualify for depreciation:

The property should be owned by the taxpayer. Besides, further improvements done on the property, typically for capital improvement, can qualify for depreciation.
The property should be deployed for an income generating, or profit generating business, by the owner and taxpayer. If it is used for both personal and commercial purpose, only commercial areas can qualify.
The property should have a useful and determinable life, for over a year.

Even when all the above criteria are met, taxpayer cannot depreciate the following properties:

Property that was used for service, then disposed of within a year.
Equipment intended for capital enhancement. Otherwise, taxpayer can include the equipments, depending on the usage.
Term interests, not all though.
So, when does a property qualify for depreciation? Right after a property is put in for business purpose; it becomes depreciable and continues until, the entire cost if recovered by the taxpayer, or with his/her retirement.

However, the taxpayer must identify the following, to make sure the depreciation value is appropriate:

What is the Depreciation Method
What is the Class life of the chosen asset
Whether or not the property is listed
Whether or not the taxpayer is looking to dispose a portion of the property
Whether or not the taxpayer can avail “bonus” depreciation for the first year
What is the Depreciable basis, for the property in question?
The correct method for deprecation is The Modified Accelerated Cost Recovery System (MACRS). Form 4562, Depreciation and Amortization, is to be used by the taxpayer, for reporting depreciation with income tax returns. The form is divided into six different sections, with instructions for filling out, given in detail.

Logically, real estate is an investment by itself, with its value appreciating every year. However, building is eligible for depreciation, though in reality, there is no loss. Since the depreciation value is shown as expense in balance sheet, it is an added saving. That’s one of the major advantages in owning a commercial property, besides all the other advantages and benefits it has to offer.

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