Help Understanding Depreciation and Improvements

6 Replies

I am trying to understand how depreciation is calculated with respect to improvements. 

Please correct me if I am wrong, but my understanding is lets say I have a property I purchased at 200k. Lets say 50k is the value of the land and 150k is the property. My basis is 150k. I can take the depreciation of this over the next 27.5 years.

Lets say I have spent 10k on a new HVAC and fixtures in year 1. This would jump my basis up to 160k.

Do I depreciate based off 150k first and then add the 10k to the new basis? Or do I take my depreciation based off the 160k?

150k/27.5 = 5454.54 

150k - 5454.54 (write this off) = 144546.46 + 10,000 = 154546 new basis 

OR

160k/27.5 = 5818

160k - 5818 (write this off) = 154182 new basis

The numbers are close, but I wanted to know if I was even in the ballpark of being correct on how this is handled and then wanted to know if there is a certain order of how the basis must be categorized, such as improvements at the end or beginning of the year.

Thanks for your help BP.

@Sean Britt

I am assuming that you started a 27.5 year depreciation schedule for the dwelling stucture when you put the property into service.  Then after the property was in service as a rental, you completed your round of improvements.  In this scenario, your project became a new depreciable asset with a new 27.5 year depreciation schedule beginning on the date you put the improvement into service..  You depreciate the cost of your improvement separately from the dwelling structure and maintain the improvement as a separate asset on your depreciation schedule with its own depreciation timeline.  

If my assumption was not correct, in that you did not put the property into service and the improvements were done to make the property ready for service as a rental, then combine the basis for the dwelling structure with your improvement cost, and depreciate the adjusted basis for the dwelling structure over 27.5 years starting on the date you place the property into service.  

Five years from now, if you replace the roof on yoru rental property, the roof becomes a new asset depreciated over 27.5 years starting on the date the new roof was put into service.   For us long term buy and hold investors, it would not be unusual for one property's depreciation schedule to have as many  as 10 separate depreciable assets, each with its own depreciation schedule.  Just the kitchen appliances alone add 5 or 6 separate depreciable assets to my property's depreciation schedule as they are replaced.

One more point.  Once you establish a depreciation basis, it never changes.  You don't adjust it each year as depreciation is taken.  Your tax basis, however, is adjusted for depreciation taken but that only comes into play when you sell or 1031 exchange.

If you are using a personal income tax software package such as TurboTax, the software will maintain your depreciation schedule and keep each new depreciable asset on its own timeline.

In your scenario, your building and your HVAC are separate depreciable items. They depreciate for 27.5 years from the date they are placed in service. They were placed in service on different dates, so they each get a separate line on your depreciation schedule.

27.5 years assumes they are residential real properties, BTW. Commercial real properties have different timelines (and under the new tax laws, different rules!)

Welcome to BP!  Best of Luck with Your Real Estate Investing!

@Sean Britt The responses you have received are excellent. One more point: not everything in the rental is 27.5 years. While additions and improvements to the property are 27.5 years, many items are 5 year, double-declining depreciation property, including appliances, furniture, floor coverings, drapes, etc.

@Sean Britt HVAC may not be considered an improvement unless it didn't have an HVAC previously. If you make the improvements the first year, you can do it the way you stated. If you do the improvements in a different tax year, you can take the depreciation that year or over a period of time.

Thanks everyone, so my understanding now is that my tax basis and depreciation amounts are going to be separate.

There was a new roof put on in 2017, before I bought the property. 

That roof is considered part of the purchase price and property basis when I bought it so there is no depreciation it is essentially included in the property amount correct? 

Lets say my Property basis for depreciation is 150k, i take my 5454.54 depreciation deduction and then year 2, i install the new HVAC system for 10k. This 10k will be on a separate depreciation schedule independent of the property itself? 

Then it looks like I just need to pay attention to what the recovery period is for what is being done? It looks like a fridge would be 5 years. Pub 527 shows carpets at 5 years also, would this be the same if I did hardwood or laminate flooring? 

I am trying to absorb all of pub 527, does anyone have any recommendations of areas I should pay special attention to inside? 

While we're on this subject, what about every other CAPEX expense outlined in the Book on Rental Property Investing?

Those items are:

Roof - 27.5 Years

Water Heater - 5 years I assume?

Appliances - 5 years

Driveway - 15 years maybe? (Same as sidewalks and roads?)

HVAC - 27.5 years

Flooring - 5 years? (Tax Code says Carpeting 5 years...)

Plumbing?

Windows?

Paint?

Kitchen Remodel? I think I saw 27.5 years above

Structure - 27.5 Years?

Components? Probably Various

Landscaping? 15 years? (Code says 15 years for certain shrubbery, etc.)

Thanks All!