{"id":142187,"date":"2022-03-28T15:35:55","date_gmt":"2022-03-28T21:35:55","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=142187"},"modified":"2024-01-05T09:06:23","modified_gmt":"2024-01-05T16:06:23","slug":"depreciation-deductions-2022","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/depreciation-deductions-2022","title":{"rendered":"Five Critical Items You Need to Review Before Filing Your Depreciation Deductions"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm?e=BIGPOC2701292907&#038;light=false\" width=\"100%\"><\/iframe>  \n\n\n\n<p><span style=\"font-weight: 400;\">As a Real Estate Tax Strategist, I review thousands of tax returns every year. Throughout my career, I\u2019ve detected a common area for mistakes: depreciation.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Depreciation is a fundamental tool for real estate investors. Improperly reporting it on your tax sheets could lead to paying thousands of dollars extra in taxes. That\u2019s why in this article, I\u2019m providing five critical items you must review on your depreciation schedules to ensure you\u2019re getting the most out of your properties.<\/span><\/p>\n<h2>Reporting Depreciation<\/h2>\n<p><span style=\"font-weight: 400;\">First, if you have any income generated by a long-term rental property owned by you or by a single-member LLC, you must report it on <\/span><a href=\"https:\/\/www.irs.gov\/pub\/irs-pdf\/f1040se.pdf\" target=\"_blank\" rel=\"noopener\"><span style=\"font-weight: 400;\">Schedule E of Form 1040<\/span><\/a><span style=\"font-weight: 400;\">.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">All ordinary and necessary expenses related to your property, including <a href=\"https:\/\/www.biggerpockets.com\/blog\/beginners-guide-depreciating-investment\" target=\"_blank\" rel=\"noopener\">rental property depreciation<\/a>, can be deducted.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But what is depreciation, anyway?<\/span><\/p>\n<p><span style=\"font-weight: 400;\">In short, depreciation represents a rental property&#8217;s declining value over time. We know that real estate tends to appreciate, but depreciation still applies and actually helps us pay less on our taxes. There are several depreciation methods, but it\u2019s important to abide by what the IRS allows. The <\/span><a href=\"https:\/\/www.irs.gov\/businesses\/small-businesses-self-employed\/tips-on-rental-real-estate-income-deductions-and-recordkeeping\" target=\"_blank\" rel=\"noopener\"><span style=\"font-weight: 400;\">IRS<\/span><\/a><span style=\"font-weight: 400;\"> prescribes a long set of rules and regulations on depreciating assets, including a standard useful life of 27.5 years for most residential rental properties.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Like I said, depreciation is great because it offsets some of the costs you incur throughout the year and lowers your tax basis. That\u2019s why reviewing these next five topics are so important!<\/span><\/p>\n<p>Before we get started, here&#8217;s a visual of what a depreciation schedule looks like:<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-142189 \" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/03\/Depreciation-schedule.jpeg\" alt=\"depreciation schedule\" width=\"2031\" height=\"611\" title=\"\" srcset=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/03\/Depreciation-schedule.jpeg 1436w, https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/03\/Depreciation-schedule-300x90.jpeg 300w, https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/03\/Depreciation-schedule-1024x308.jpeg 1024w, https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/03\/Depreciation-schedule-768x231.jpeg 768w\" sizes=\"auto, (max-width: 2031px) 100vw, 2031px\" \/><\/p>\n<h2>Five Items To Review On Your Depreciation Schedule<\/h2>\n<h3>1. Review All Listed Totals<\/h3>\n<p><span style=\"font-weight: 400;\">It seems obvious, but the first thing you must do is check the property\u2019s total depreciable value. For the most part, you\u2019re just making sure the total is less than the purchase price. Keep in mind that some costs such as inspections, due diligence fees, and more will be included in your depreciable basis but the total should never equal or amount to more than your purchase price.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">For instance, if the depreciable value equals $200,000 but your purchase price totaled $150,000, you should consult with your tax professional.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Errors over depreciable value occur all of the time, especially when determining land values. Since land isn\u2019t depreciable, the solution is to use a ratio against the total value of the property, then multiply by the purchase price for a lower land value that helps reduce the tax basis. This is the same method a county tax assessor uses.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But say, for example, a tax preparer uses an actual land value of $50,000 instead of applying a ratio. With the building included, the total tax basis equals $160,000.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The problem? The client paid $120,000 for the property. This mistake accidentally gave the client an extra $40,000 on their basis!<\/span><\/p>\n<p><span style=\"font-weight: 400;\">An awful mistake like this can be prevented by simply being vigilant about the numbers posted in your depreciation schedule.<\/span><\/p>\n<h3>2. Make Sure Land Is Accounted For<\/h3>\n<p><span style=\"font-weight: 400;\">To expand further on the topic of land, it\u2019s important that your depreciation schedule accounts for it, despite it not being depreciable.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">What do I mean?<\/span><\/p>\n<p><span style=\"font-weight: 400;\">If you paid $200,000 for a rental property and all $200,000 is listed as the depreciable amount, something is wrong. You\u2019re essentially stating that you are, in fact, depreciating the land, since the purchase price is equal to the depreciable amount.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">You cannot do this. As mentioned earlier, you should use the county tax assessors ratio to determine a proper land value in depreciation.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">In the event you fail to do this and continue to deduct depreciation year-over-year, you\u2019ll be facing serious back pay when the error is found and corrected.<\/span><\/p>\n<h3>3. Make Sure Renovation Expenses Are Broken Down When Possible<\/h3>\n<p><span style=\"font-weight: 400;\">If you had a major renovation, look to see if it is listed as a lump sum amount on the depreciation schedule. If you spent $40,000 on a renovation that included $10,000 worth of landscaping and $5,000 on new appliances, there may be a more advantageous way of reporting it.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">A major renovation is assumed to be a 27.5-year improvement, the same useful life of a rental. However, there are some improvements that have been assigned shorter lives.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Landscaping, for example, falls into a category known as land improvements, which have a life of 15 years. Additionally, any assets with a life of less than 20 years can potentially be expensed in the first year of ownership using bonus depreciation.\u00a0\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">There are lots of potential savings with renovations. I highly recommend having a conversation about it with your tax professional.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Beware of errors, though.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">For instance, we once had a client who was considered a real estate professional (meaning they could deduct unlimited rental losses). They had been buying 2-3 new rentals each year, completing major renovations on each. Their prior depreciation schedule listed \u201c$82,000 Renovations over 27.5-years\u201d for every property. This resulted in a depreciation deduction of about $2,980 for the year. <\/span><\/p>\n<p><span style=\"font-weight: 400;\">However, when we broke down the components of the renovations, there was a lot of depreciation left on the table:<\/span><\/p>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">$8,000 &#8211; Landscaping<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">$6,200 &#8211; Appliances<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">$2,000 &#8211; New fencing\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Total: $16,200 &#8211; Assets with a life of fewer than 20 years, qualifying for year one bonus depreciation\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Total value: $63,800<\/span><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">With these numbers, the client could have taken a much larger depreciation deduction of $18,520 for the year.<\/span><\/p>\n<h3>4. If You&#8217;re Using Delayed Financing Methods, Make Sure Your Tax Pros Know<\/h3>\n<p><span style=\"font-weight: 400;\">If you run a delayed financing strategy where you place your renovation costs into escrow when you purchase, your tax professional could be shorting you on depreciation. This is because many tax professionals do not realize the structure of this type of transaction. They are likely taking the full renovation amount and lumping it into the purchase price, then allocating the total amount between land versus building.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This is incorrect. The allocation should only apply to the purchase price. The renovation amount should be accounted for separately.\u00a0\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Let\u2019s say a client\u2019s prior CPA took the full amount of their HUD property \u2014 where they prepaid renovation costs to allow for earlier refinancing via the BRRRR method \u2014 as their purchase price. The totals would show $30,000 for the purchase price and $40,000 for the renovation escrow (ignoring miscellaneous closing costs).<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Their initial depreciation was calculated as:<\/span><\/p>\n<p><span style=\"font-weight: 400;\">$70,000 Purchase price * 82% building value (per the tax assessor\u2019s ratio) = $57,400 depreciable value at 27.5 years for a deduction of $2,087 per year.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">However, because of the strategy the client used, the depreciation should have been:<\/span><\/p>\n<p><span style=\"font-weight: 400;\">$30,000 purchase price * 82% building value = $24,600 depreciable value at 27.5 years for a deduction of $895 per year and a $40,000 renovation value (which could have likely been broken down further as we did earlier) at 27.5 years for a deduction of $1,454 per year. That amounts to a total annual depreciation deduction of $2,350 per year.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">It might not seem like a lot, but this client had nearly ten properties that were all depreciated using the traditional, but inappropriate method for their strategy. As you can see, it resulted in a lost depreciation deduction of close to $4,000 per year, which would continue across multiple years.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The good news is that we were able to correct it by utilizing <\/span><a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-form-3115\" target=\"_blank\" rel=\"noopener\"><span style=\"font-weight: 400;\">Form 3115<\/span><\/a><span style=\"font-weight: 400;\"> and recoup the deduction.\u00a0<\/span><\/p>\n<h3>5. Be Aware Of Service Dates<\/h3>\n<p><span style=\"font-weight: 400;\">Your rental is eligible for depreciation when it is \u201cin service\u201d, meaning ready and available for rent.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Normal vacancies or spans of non-occupancy for renovation do not take a property out of service. If you were to buy a rental with tenants in it, issue them a 60-day notice to vacate, then spend 90 days on a renovation, the property is still in service throughout that time.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Review the dates listed for your rental asset and any renovation dates. Many preparers will ask for an in-service date, but won&#8217;t ask if the rental was occupied when first purchased. They&#8217;ll just utilize the purchase date.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">That&#8217;s why it&#8217;s important to note if a property is purchased vacant. If you buy on January 1<\/span><span style=\"font-weight: 400;\">st<\/span><span style=\"font-weight: 400;\"> but require a six-month renovation, the property won&#8217;t be in service until the end of those six months.<\/span><\/p>\n<h2>Conclusion<\/h2>\n<p><span style=\"font-weight: 400;\">With tax day quickly approaching, it\u2019s important to review depreciation concepts and make sure you\u2019re on top of your filing requirements.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Hopefully, this checklist has served as a useful guide for you and your business!<\/span><\/p>","protected":false},"excerpt":{"rendered":"<p>As a Real Estate Tax Strategist, I review thousands of tax returns every year. Throughout my career, I\u2019ve detected a common area for mistakes: depreciation. Depreciation is a fundamental tool [&hellip;]<\/p>\n","protected":false},"author":4784,"featured_media":142194,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7119,7377],"tags":[],"class_list":["post-142187","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-biggerpockets-daily","category-tax-strategies"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/142187","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/4784"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=142187"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/142187\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/142194"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=142187"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=142187"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=142187"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}