I bought my first investment property last year and I am now preparing my taxes. Can I depreciate the property to reduce my taxable income?
Yes, absolutely. Actually, the I.R.S. will expect depreciation to be calculated from the sale of an investment property in order to increase the amount of taxable gains you had on the property, so it’s in your best interest to make sure you take advantage of depreciation during ownership.
So what can you depreciate? Not only can you depreciate the building, but you can depreciate any additional capital investments you made as well, which carry a minimum depreciation schedule of three years. These are commonly referred to as capital expenditures or CAPEX improvements. Here are some examples of what can be depreciated besides the building itself:
- appliances including refrigerators, washing machines, dishwashers, and stoves
- capital improvements such as a kitchen or bath remodel
- new windows
- full roof replacement
- leasehold improvements such as electrical system overhauls or new septic systems
- landscaping improvements
- legal fees, if carved out separately from the original purchase amount, and
- equipment used to maintain the property, such as landscaping equipment or cleaning appliances.
(For more on how your investment property can be depreciated, see the Nolo article How Landlords Can Deduct Long-Term Assets.)
You will note that land is not included in the list. Land is not a depreciable asset and you cannot take deductions on it, as land was there before the buildings and improvements were put on it, and it will remain once they are long gone. You also can’t depreciate repair costs or service contracts. Those can be deducted from your net income as expenses, but are not depreciable items.
The time period for deducting depreciation depends on the type of investment. If the property is a commercial property, then the depreciation period is 39 years (as opposed to 27.5 years for residential property). Using a straight line depreciation method for a commercial property costing $2 million dollars, for example, you would receive an annual deduction of $51,282 ($2M / 39 = $51,282). Your annual net income is thereby reduced by that amount, for tax purposes, reducing the amount of taxes you owe to the IRS.
Unlike the building itself, items such as appliances or equipment typically fall on a shorter five- or seven-year depreciation schedule, because of their expected life. Furnaces on the other hand typically carry a depreciation schedule in line with the building itself, whether it is a residential or commercial property. For a breakdown of depreciable items and their corresponding schedules, see Chapter 2, Depreciation of Rental Property, in IRS Publication 527, Residential Rental Property. Chapter 2 is relevant for commercial properties, however, additional detail can be obtained on commercial investments from Chapter 4 in IRS Publication 946, How to Depreciate Property.