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Overview of Investment Property Depreciation

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One of the great things about investment property is that you can deduct your legitimate business expenses.  Things such as utility bills, real property taxes, mortgage interest, tenant verification costs, mileage, property insurance, and repair and maintenance expenses are all acceptable rental tax deductions.  Deducting expenses like these help to reduce your tax liability, which will either increase the size of your tax refund or decrease the amount you owe.  Another excellent tax deduction is the concept of property depreciation.

Depreciation is a tax deduction that is designed to compensate property owners for normal wear and tear to their property.  The rationale is that making upgrades and repairs associated with normal wear and tear costs money, and therefore is a tax deductible expense.  Importantly, depreciation applies only to the actual building and not the land on which it sits, and it can be calculated for 27.5 years.

Your accountant should determine the appropriate method of calculating your annual depreciation expense, but in general the most common approach is the straight-line method.  This allows you to depreciate an equal amount every year for 27.5 years.  For example, if you buy a property for $100,000 and the land is estimated to account for 20% of the total value, then your baseline value for depreciation will be $80,000 ($100,000 x 80%).  By dividing $80,000 by 27.5 years, we can calculate that your annual depreciation deduction will be $2,909. 

There are a few other things to keep in mind with regard to depreciation, and your accountant should be able to guide you.  For example, depreciation is not optional – you must deduct it.  Luckily if you forget to deduct it, you can make up for it on a future tax return (must be within the subsequent 3 year period).  Additionally, your specific calculation of depreciation and the underlying calculation values might differ depending on your unique situation.  So again, always make sure you are getting an expert opinion on this and all other tax issues.

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