As a result, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. For more information about improvements, see Additions or improvements to property, later in this chapter, under Recovery Periods Under GDS. If you placed rental property in service before 1987, you are using one of the following methods. During August and September, you made several repairs to the house.

You then claim back that expense over the useful life of the property. You will owe 25 percent of what you could have deducted as a “depreciation recapture” when you sell the property. By not reporting, you also miss out on benefits like depreciation and the chance to carry forward losses.

Table 2-1 shows the ADS recovery periods for property used in rental activities. You purchased a stove and refrigerator and placed them in service in June. Your basis in the stove is $600 and your basis in the refrigerator is $1,000. Using the half-year convention column in Table 2-2a, the depreciation percentage for Year 1 is 20%. For that year, your depreciation deduction is $120 ($600 × 20% (0.20)) for the stove and $200 ($1,000 × 20% (0.20)) for the refrigerator.

• The IRS classifies rental property income as “passive activity,” meaning it’s generally not subject to self-employment tax.
• You must be able to document this information if your return is selected for audit.
• The basis for depreciation on the house is the FMV on the date of the change ($147,000) because it is less than your adjusted basis ($164,000).
• If you report a loss on line 26, 32, 37, or 39 of your Schedule E (Form 1040), you may be subject to a business loss limitation.
• The IRS Video portal (IRSVideos.gov) contains video and audio presentations for individuals, small businesses, and tax professionals.

Passive Activity Limits

Rental property depreciation is the rate at which real estate investors can depreciate their property and take tax deductions on it. The IRS permits rental property owners to deduct a set percentage of the property’s cost basis from the taxes owed on the generated income over the useful life of the property. Typically, the rental property depreciates over 27.5 years, at a rate of 3.64% per year. After determining the basis, the next step involves dividing this value by the recovery period determined by the IRS, typically 27.5 years for residential properties.

Generally, you cannot deduct expenses that are solely personal and unaffiliated with the rental property. These could include personal purchases of food, clothing, or travel. In many cases, you may find yourself temporarily staying at a rental property you own—for example, you may stay on-site to perform repairs on your own. If your tenant offers to trade services in exchange for rent, you must include the fair market value of the services as income. For example, if your tenant paints the rental house in exchange for one month’s rent (valued at $1,000), you must include the $1,000 as income even though you didn’t receive the cash. The basis of the property is the amount you paid (in cash, with a mortgage, or in some other manner) to acquire the property.

You can’t deduct special assessments you pay to a condominium management corporation for improvements. However, you may be able to recover your share of the cost of any improvement by taking depreciation. This chapter discusses some rental real estate activities that are subject to additional rules. If you have more than three rental or royalty properties, complete and attach as many Schedules E as are needed to separately list all of the properties.

How is depreciation taxed on the sale of rental property?

• The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election.
• The following examples show how to determine whether you used your rental property as a home.
• For more information, see Used as a home but rented less than 15 days under Reporting Income and Deductions in chapter 5.
• However, don’t use that schedule to report a not-for-profit activity.
• If you don’t report this income, you could face penalties, interest on unpaid taxes, or even audits.
• Aside from maybe having to hire an accountant to help you keep track of your depreciation schedule, there is little downside to depreciating a rental property (which you probably should have anyway).

When selling rental property, clients will face a capital gains tax (the rate depends on their taxable do you have to depreciate rental property income and filing status), and a depreciation recapture tax rate that is capped at 25%. Clients with a higher income may also be subject to net investment income tax (NIIT). Depreciation can save real estate investors hundreds of thousands of dollars over the life of the property. However, the IRS has strict rules regarding rental property depreciation, so be sure you consult a tax professional to get the full deduction. You should also be familiar with how rental property depreciation recapture works before you sell your property. If you use a dwelling unit as a home and you rent it less than 15 days during the year, its primary function isn’t considered to be rental and it shouldn’t be reported on Schedule E (Form 1040).

Your basement apartment was used as a home because you used it for personal purposes for 30 days. Your personal use (30 days) is more than the greater of 14 days or 10% of the total days it was rented (27 days). The following examples show how to determine whether you used your rental property as a home.

How do you avoid depreciation recapture tax on rental property?

You are using your beach house for personal purposes on the days that Rosa uses it because your house is used by Rosa under an arrangement that allows you to use her cabin. The following examples show how to determine if you have days of personal use. A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons. If you own a condominium, you also own a share of the common elements, such as land, lobbies, elevators, and service areas.

Personal Expenses

The basis for depreciation on the house is the FMV on the date of the change ($147,000) because it is less than your adjusted basis ($164,000). A condominium is most often a dwelling unit in a multi-unit building, but can also take other forms, such as a townhouse or garden apartment. Because you placed the property in service in February 2019, you continue to use that row of Table 2-2d.

You and the other condominium owners may pay dues or assessments to a special corporation that is organized to take care of the common elements. If you are married, determine whether you materially participated in an activity by also counting any participation in the activity by your spouse during the year. Do this even if your spouse owns no interest in the activity or files a separate return for the year. Losses from holding real property (other than mineral property) placed in service before 1987 aren’t subject to the at-risk rules.

Under GDS, the recovery period of an asset is generally the same as its property class. Under MACRS, property that you placed in service during 2024 in your rental activities generally falls into one of the following classes. You must decrease the basis of your property by any items that represent a return of your cost. For more information about deducting or capitalizing costs and how to make the election, see Carrying Charges in sections 263A and 266. However, you can deduct assessments for the purpose of maintenance or repairs or for the purpose of meeting interest charges related to the improvements.