Calculating depreciation for property improvements


Calculate Basis
  1. Get your Settlement Statement and Home improvement bills
  2. Subtract the following closing items on the settlement statement from the total purchase price: loan origination fee, points paid, mortgage insurance premium, loan assumption fees, credit report cost, amounts contributed to escrow, property insurance premiums and appraisal fees. Those costs are not considered part of your basis in the property.
  3. Add the total cost of capital improvements to the adjusted cost basis determined in Step 2
  • You can't include in your basis the fees and costs for getting a loan on property. A fee for buying property is a cost that must be paid even if you bought the property for cash
  • Expenses you must pay to obtain title to your home are added to the home's tax basis
Calculate Depreciation
  1. Divide the annual depreciation amount allowed by 12 to determine the monthly depreciation amount.
  2. Calculate the number of months during the tax year that the property was available for rent or rented. If the property was placed in service--available for rent--for the first time during the current tax year, count the first month the property was available for rent as half a month regardless of the actual date the property was available for rent. The IRS requires all residential rental property to use the mid-month convention for the date placed in service.
  3. Multiply the monthly depreciation amount calculated in Step 1 by the number of months during the tax year that the property was available for rent. That is your total depreciation deduction for the year.

Depreciating improvements after property has been rented already

Renovations to rental houses and apartment buildings have a 27.5 year depreciation period, while renovations on commercial properties get depreciated over 39 years. Take the cost of the renovation and divide it by the depreciation period. For example, if you built a $75,000 addition on a house or apartment building, you would divide it by 27.5 to find the annual depreciation of $2,727.27. A $150,000 overhaul of a commercial building's plumbing system gets divided by 39 to find an annual depreciation allowance of $3,846.15.

  1. Completing Form 4562: On Form 4562, enter the annual depreciation as a separate line item on line 19h for residential properties or line 19i for commercial properties. You'll need to enter a description of the item, the date the work was completed, the total depreciable cost, and the annual depreciation amount. Combine the depreciation from your renovations with all of your other depreciation allowances, and enter the sum on line 22 of Form 4562.
  2. Carrying Depreciation Over to Schedule E: Combine the depreciation for the renovation with the depreciation for the building as a whole, and enter that sum on line 18 of the column corresponding to the property you renovated on your Schedule E form. Then combine the depreciation with all of your other expenses to reduce the taxable income from your property.

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  • 3 months ago by vince