How is Cost Basis for Depreciation Determined?

Question

I purchased a two family foreclosure for cash in 2016, rehabbed and rented. Have not financed yet. I am about to have my taxes done and want to be prepared. For purposes of depreciating the property, how do I determine the value of the property? I don't want to use the purchases cost. I suppose I could you purchase plus rehab costs? There is likely more equity though so ideally I would like the cost basis to reflect the full value.

Pete M.

Steven Hamilton II · Answer

Purchase plus rehab costs minus land value is what is depreciated. Your loan costs should be amortized over the life of the loan.

Paul Caputo · Answer

Depreciation is based on what you paid for the property and it allows you to recover some of your purchase costs over the useful life of the property. The only way you could use the FMV for depreciation is if that is what you paid for the property. The IRS doesn't let you use anything but the actual cost for your cost basis.

There is one way to be able to use the FMV, but it takes some extra steps. You could create an S corp and sell the property to the S corp for FMV. You get cash out at FMV and the S corp would have a mortgage on the property that you'd be responsible for going forward. Since the S corp bought the property at FMV that would be your depreciable cost basis less land value. But you gotta be careful with this since if you overstate FMV the IRS can come after you since your depreciation would be higher than it should be. I'd recommend getting a CPA and real estate tax attorney involved if you're going to do this. As far as I know there is no other way to get your cost basis up to FMV.

If you want to get the most out of your depreciation deductions you should have a cost segregation study done on the property which will identify assets for accelerated depreciation which significantly reduces your tax liability. PM me for more info on cost segregation studies.

Peter Morrissey · Answer

Thanks. The reason I mentioned the loan was that I expect that it will be appraised higher than the purchase plus rehab costs and was wondering if there was a way I could use the market value.