Depreciable Real Estate (Tax) Realty

Depreciable Real Estate Overview

Depreciable real estate refers to real estate property subject to depreciation rules as delineated under Section 167 of the Internal Revenue Code (IRC). Depreciation is a non-cash deduction that spreads the cost of acquiring property over its useful life, reflecting usage, wear, and tear. The main categories of depreciable real estate include property used in trade or business activities as well as investments. However, land is excluded from depreciation calculations because it does not wear out over time.

Examples

Residential Rental Property: Sarah purchases a residential property for $500,000, where $50,000 is allocated to land and $450,000 is the value of the building. Using the straight-line method, she can depreciate the $450,000 over a 27.5-year period.
Commercial Office Building: Mike acquires an office building for $2 million. Here, $200,000 is assigned to the land value and $1.8 million to the building. The depreciable amount of $1.8 million will be spread over a 39-year period using applicable depreciation methods.

Frequently Asked Questions (FAQs)

What constitutes depreciable real estate? Property used in a trade or business or for investment, such as rental houses and commercial buildings, that loses value over time due to use and wear.

Can land be depreciated? No, land itself is non-depreciable as it does not wear out, become obsolete, or get used up.

How do you calculate depreciation for real estate property? Depreciation is calculated by dividing the depreciable basis (cost minus land value) by the useful life of the property, which is 27.5 years for residential and 39 years for commercial properties under the straight-line method.

What are the common methods of depreciation? The most commonly used method for real estate is the straight-line method, where an equal amount is deducted each year. Other methods include accelerated depreciation methods like Modified Accelerated Cost Recovery System (MACRS).

Is depreciation mandatory? No, depreciation is not mandatory but it is highly beneficial as it can reduce taxable income, leading to tax savings.

Straight-Line Depreciation: A method where an equal depreciation amount is deducted every year over the useful life of the property.
Internal Revenue Code Section 167: The section that outlines the tax rules for depreciation deductions.
Modified Accelerated Cost Recovery System (MACRS): A method of depreciation in the US that allows the capitalized cost of an asset to be recovered over a specified life through annual deductions.
Useful Life: The estimated duration that a property will be productive for its intended use.

Online Resources

References

Internal Revenue Service. “Publication 946: How to Depreciate Property.” Rev. 2021.
Internal Revenue Service. “Publication 527: Residential Rental Property.” Rev. 2020.

Suggested Books for Further Studies

Goolsby, William, “Real Estate As an Investment: A Textbook.” Thomson Reuters.
Fisher, Julian E., and Gibson, Paul, “Real Estate Taxation: A Practitioner’s Guide,” American Bar Association.
Evans, Frank W., and Schmitz, Mark A., “Real Estate Investment Analysis and Taxation,” Dearborn Real Estate Education.

Real Estate Basics: Depreciable Real Estate Fundamentals Quiz

### Does depreciation apply to both the building and the land it is on? - [ ] Yes, both the building and the land can be depreciated. - [x] No, only the building can be depreciated. - [ ] Depreciation does not apply to real estate at all. - [ ] Both the building and land depreciate equally. > **Explanation:** Depreciation only applies to the building itself and not the land it is located on. Land typically does not lose value over time, whereas buildings do due to wear and tear. ### Over how many years must residential property be depreciated according to tax laws? - [x] 27.5 years - [ ] 15 years - [ ] 30 years - [ ] 39 years > **Explanation:** According to tax laws, residential properties must be depreciated over a 27.5-year term. This allows for an annual deduction related to the depreciation. ### Over how many years must commercial property be depreciated according to tax laws? - [ ] 27.5 years - [ ] 30 years - [x] 39 years - [ ] 45 years > **Explanation:** According to tax laws, commercial properties must be depreciated over a 39 year term. This extended period helps distribute the depreciation deduction over a longer time frame. ### Which type of property allows for depreciation as an income tax deduction? - [ ] Personal-use property - [ ] Land - [x] Income-producing property - [ ] All types of property > **Explanation:** Depreciation can be used as an income tax deduction for businesses for properties that are used for income-producing activities. Properties used for personal purposes do not qualify for depreciation deductions. ### What must a property have for it to qualify for depreciation? - [x] A useful life of at least one year - [ ] A mortgage attached to it - [ ] An appraisal conducted every three years - [ ] Equal use between personal and business > **Explanation:** To qualify for depreciation, the property must have a continued useful life of at least one year and must be used for an income-producing activity. ### Who provides the allowance for the normal wear and tear of a piece of property? - [ ] Real estate agents - [ ] Local municipalities - [ ] Property management companies - [x] The Internal Revenue Service (IRS) > **Explanation:** The Internal Revenue Service (IRS) provides an allowance for the normal wear and tear of a piece of property, which can be deducted from taxable income through depreciation. ### When filing an annual tax report, who can claim depreciation? - [ ] Any resident of the United States - [ ] Any homeowner regardless of purpose - [x] Individuals or businesses that own income-producing property - [ ] Only those with newly built properties > **Explanation:** Only individuals or businesses that own income-producing property and meet other specified criteria can claim depreciation when filing an annual tax report with the IRS. ### Depreciation is used to offset which type of expense for businesses? - [x] Income tax liability - [ ] Mortgage interest - [ ] Utility expenses - [ ] Insurance premiums > **Explanation:** Depreciation can be used as an income tax deduction, effectively reducing the income tax liability of a business. ### Why is depreciation especially important for businesses? - [ ] It is a source of immediate revenue. - [ ] It increases the value of properties. - [x] It allows for a significant tax deduction over time. - [ ] It avoids the need for any property-related expenses. > **Explanation:** Depreciation is important for businesses as it allows for a significant tax deduction over time. This tax benefit can improve the financial condition of the business by reducing tax liabilities. ### What aspect of a property predominantly affects its depreciation schedule? - [x] Whether it is residential or commercial - [ ] The construction material used - [ ] The color of the building - [ ] The landscape quality > **Explanation:** The depreciation schedule is predominantly affected by whether the property is residential or commercial, with residential properties having a 27.5-year term and commercial properties having a 39-year term.