When you invest in rental property in Orange County, there are many benefits you should know about! There’s the obvious income you’ll receive from tenants living in your rental property, but there are also numerous tax benefits and deductions you can take on rental property. This includes depreciation, which works a little differently than the rest, but can still be very beneficial. The Hakola & Associates team is here to fill you in!
First of all, it’s important to know the IRS requirements you need to meet in order to depreciate a rental property:
1. You own the property and are considered the owner even if the property is in debt.
2. You use the property in your business or as income-producing activity.
3. The property has a determinable useful life. This means that it wears out and decays over time and loses value from natural causes.
4. The property is expected to last more than one year.
Therefore, your investment property must be a structure that decays over time rather than just land, which does not depreciate. Landscaping or clearing on the land cannot be depreciated either.
You can begin depreciating a rental property once it is advertised and ready to be occupied, and you can continue depreciating until you deduct the entire cost or other basis in the property, or you retire the property from service.
How much depreciation you can claim on your Orange County rental property depends on many factors, including the basis in the property, the recovery period and the depreciation method used. Any residential property placed in service after 1986 uses a technique that spreads costs and depreciation deductions over 27.5 years.
Here are the basic steps for calculating deprecation:
1. Determine the basis of the property, which is the amount you paid, settlement and closing cost fees, any amount the seller owes that you agree to pay, title insurance and more. However, depending on the situation, some settlement and closing cost fees cannot be included in your basis.
2. Separate the cost of land and buildings, since you can’t depreciate the land value. Use the fair market value of each at time of purchase, or base the numbers on the assessed real estate tax values.
3. Determine your basis in the house, and the adjusted basis, if necessary.
It is wise to use professional assistance from a tax accountant when determining these numbers! Then you must decide which system you will use for depreciation, the General Depreciation System, or GDS, or the Alternative Deprecation System, or ADS.
More details can be found in this Investopedia article. If you have questions, or you would like professional assistance with purchasing investment property, 1031 exchanges or any other real estate endeavor in the Orange County real estate market, contact us! The Hakola & Associate Team is here to help you accomplish all of your real estate goals this year.