In case you have purchased property that you would like to rent or converted a formerly owner-occupied unit to leasing property, you cannot deduct the whole price of the property from the year where you purchased it. The Internal Revenue Service, IRS, believes property a capital asset, meaning it has a useful life of over 1 year. The price of all capital resources must be allocated over the useful lifetime of the asset as determined by the IRS. Current IRS regulations require you to depreciate all rental home with the Modified Accelerated Cost Recovery System, MACRS. Before you can calculate property depreciation, you must establish the cost basis in the asset.
Find the settlement statement for the property and find the total amount paid for or financed to your home, including all closing costs.
Subtract the subsequent closure things on the settlement statement from the total purchase price: loan origination fee, points paid, mortgage insurance premium, loan assumption fees, credit report price, amounts contributed to cost, property insurance premiums and evaluation fees. Those costs aren’t considered a part of your basis in the property.
Total the cost of all capital improvements made to the property in order to prepare it for leasing. Capital improvements include improvements to the house that extend the useful life of the house, such as roof replacement, fence replacement and additions to the house.
Insert the total price of capital improvements to the adjusted price basis determined in Step 2.
Get the recovery period designated by the IRS for the rental home. As of 2010, the recovery period for residential rental property is 27.5 years.
Divide the total basis in the property by the IRS-designated recovery period. That is the whole amount of depreciation allowed for a year.
Divide the yearly depreciation amount allowed by 12 to ascertain the monthly depreciation amount.
Figure out the number of months during the taxation year that the property was available for rent or rented. If the home was put in service–available for rent–for the first time during the current tax year, then count the first month that the property was available for rent as half a month irrespective of the actual date that the property was available for rent. The IRS requires all residential rental property to utilize the mid-month conference for the date put in service.
Multiply the monthly depreciation amount calculated in Step 3 by the number of months during the taxation year that the property was available for rent. That is your overall depreciation deduction for the entire year.