How to Calculate Depreciation in Real Estate

In the real estate industry, depreciation is a powerful tool for owners of rental properties. In addition to lowering your taxable income, it allows you to deduct the costs of purchasing and renovating a property over its lifetime. That’s why it is essential to learn how to calculate depreciation in real estate.

When you buy and improve a rental property, you can deduct those costs through depreciation. In contrast to taking a single large deduction when you buy or improve a property, depreciation spreads the deduction out over its useful life.

A Guide to Calculating Depreciation: Modified Accelerated Cost Recovery System

In the United States, depreciation is generally calculated using the Modified Accelerated Cost Recovery System (MACRS). It assigns assets to different asset classes, and those asset classes determine the asset’s useful life. Depreciation according to MACRS can be calculated using methods such as the double declining balance and the sum of the years’ digits.

MACRS is more complex than other depreciation methods since it takes into account a wider range of factors. It should be noted, however, that the simple MACRS formula is the cost basis of the assets x depreciation rate. Additionally, IRS Pub 946 provides detailed tables on depreciation rates, percentage tables, and methods.

Real estate depreciation is calculated by subtracting the value of the property itself from the value of the land, plus qualifying closing costs. Depending on the method of depreciation used, this is divided by the useful life of the property. The final step is to calculate how much depreciation you can claim in the first year and over time using a depreciation schedule.

Double-Declining Balance Depreciation

The double declining balance (DDB) depreciation method is a slightly more complicated approach for depreciating assets. A greater amount of the asset’s value can be written off immediately after you buy it, and less later on.

These are great for companies that wish to recover a greater amount of value upfront from an asset—since the asset loses value quickly during the first few years after purchase.

Below is the depreciation formula for real estate each year:

(Cost of asset / Length of useful life in years) x 2 x Book value at the beginning of the year

This method depreciates an asset twice in its first year, as compared with straight-line depreciation. In subsequent years, you’ll depreciate the asset based on its remaining book value rather than its original cost.

Essentially, book value is what the asset is worth minus what you have already written off. In the double-declining balance method, salvage value is not taken into account.

Sum-of-the-Year’s Digits Depreciation

Sum-of-the-year’s digits (SYD) depreciation is yet another method for depreciating assets more rapidly during their early years of use. This method is suitable for companies who want to recover more of an asset’s value upfront, but with a slightly more even distribution than double-declining balances.

SYD depreciation is calculated by adding up the digits in an asset’s useful life to obtain a fraction for each year of depreciation. For instance, a five-year asset would have a SYD of 15: 1 + 2 + 3 + 4 + 5 = 15. The formula for this method would be:

YR(Purchase Price − Salvage Value) / SYD Factor

Calculate your write-off by dividing the asset’s remaining lifespan by the SYD and multiplying the result by its cost. 

Depreciation Criteria For Rental Properties

Investors can claim rental property depreciation expenses only if the property qualifies for depreciation. An investor can claim depreciation for a rental property if they meet the following criteria:

  • The investor must own the property and not be a tenant.
  • Property must be used for business or investment purposes, including as a rental property for tenants.
  • An assessment of the property’s useful life must be possible, hence a land value cannot be depreciated.

In order to claim depreciation, an investor must hold a property for at least one year before claiming deductions.

Maximizing Real Estate Investment Returns Through Depreciation and Tax Planning

The revenue of an investment property can be greatly impacted by real estate devaluation, which plays a significant part in real estate financing. Depreciation enables investors to write off a part of the property’s worth each year, lowering their taxable revenue and total tax burden. Since the tax savings may boost the property’s revenue flow, this could result in better returns on investment.

One strategy for maximizing returns through tax planning is to perform a cost segregation study. This study can help identify assets within the property that can be depreciated more quickly, resulting in a higher tax deduction in the early years of ownership. Additionally, investors may consider using a 1031 exchange to defer taxes on the sale of a property by reinvesting the proceeds into a like-kind property. Careful planning and consideration of real estate depreciation calculations can help investors optimize their returns and make informed investment decisions.

Tax Benefits From Real Estate Investments

Among real estate investors’ greatest tax benefits is rental property depreciation. As property ages, depreciation deductions help offset the ongoing maintenance costs. Rental properties are an excellent investment because depreciation allows you to reduce your tax bill each year by spreading out the cost of buying the property over decades.

In light of these benefits, you should keep tax breaks in mind when structuring investments as part of your financial planning. With Saint Investment Group, investors can reduce risk and gain more stability in their real estate investments. Investment opportunities are carefully selected by our team from various property types in order to balance overall risk and ensure long-term stability for real estate funds

Check out our website for more free investment resources or connect with our team to learn how we can provide a passive income for you. Email us at info@saintinvestment.com or contact us at 949-881-7128 at Saint Investment Group today!

Frequently Asked Questions:

What is real estate depreciation?

Real estate depreciation is the term used to describe how a property’s worth declines over time as a result of wear and tear, aging, and other variables. Property owners can use it as a tax exemption to recoup some of the expenses related to buying and keeping a home.

What is the formula for calculating real estate depreciation?

Real estate depreciation is calculated using the following formula: (Cost of the building – Ground value) / Depreciation term.

What are the different methods of real estate depreciation calculation?

The two most common methods of real estate depreciation calculation are the straight-line method and the accelerated method, such as Modified Accelerated Cost Recovery System (MACRS).

What is the straight-line method of real estate depreciation calculation?

The straight-line method of real estate depreciation calculation spreads the cost of the property evenly over its depreciation period. It is the simplest and most widely used method of real estate depreciation calculation.

What is the accelerated method of real estate depreciation calculation?

The accelerated method of real estate depreciation calculation allows property owners to deduct a larger portion of the cost of the property in the early years of ownership. This method is more complex and requires more detailed record-keeping than the straight-line method.

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