Juggling the expenses and tax rules that you are faced with as a vacation rental owner? We’ve got some good news for you! There are significant deductions you can make to your taxable income and we’ll be focusing on one of the most important ones: vacation rental property depreciation.
The Internal Revenue Service (IRS) is the tax-collecting federal agency behind the United States government. Before diving into this topic, we recommend taking a look at Chapter 2 of Publication 527.
We know it can get confusing so we’ve prepared a free rental property depreciation calculator for you. In this article, you’ll also find a thorough explanation of what vacation rental depreciation is, what rules you need to follow, and how you can maximize it. Let’s get started!
What Is Rental Property Depreciation?
Vacation rental property tax depreciation is defined as recovering the cost of a property used as a business throughout its useful life (which is 27.5 years). By depreciating a property, you deduct costs from your tax return on a yearly basis. This process begins when you place the property in service for generating income.
The reason depreciation is such an important tool for property owners is because over time, they can deduct the cost of purchasing the property and the improvements made. The amount that you can deduct depends on your basis in the property, the recovery period, and the depreciation method that is used.
Once the cost or basis of your rental property has been fully recovered, you’re required to stop depreciating the property.
Vacation Home Depreciation Rules
There are certain rules and regulations that are put in place to determine whether a property can be depreciated or not. The IRS states that in order to depreciate your property, you must meet the following four requirements:
You’re the owner of the property
Only the owner of a property can depreciate it. This means that if someone else rents out your rental, they can’t actually depreciate it. There is, however, an exception to this rule if they make permanent improvements to your leased property.
The property is used for business and generates income
A vacation rental property is considered a business if it’s used for personal reasons for less than 14 days of the year or 10% of the total days it’s rented out (at a fair rental price).
The property has a quantifiable useful life
Also known as having a determinable useful life, your property must be something that loses its value over time with an estimated duration of utility. This can include becoming obsolete, losing value from natural causes, or getting worn out. However, a property doesn’t need to be in bad condition to be depreciated.
It’s expected to last more than a year
For a property to be eligible for depreciation, it must have a life expectancy of over a year.
Examples of Properties That Can’t Be Depreciated
It’s important to know that there are several types of properties that can’t be depreciated. This includes land and excepted properties. Land can’t be depreciated because it doesn’t run out or get used up. The maintenance costs (such as landscaping and planting) are not covered either unless they are closely associated with the rental home.
You also can’t depreciate property that is put in and out of business in the same year or the equipment in it that is used to build capital improvements.
Different Depreciation Methods
The general depreciation method is the Modified Accelerated Cost Recovery System (MACRS). This is used for any rental property that was put in business after 1986.
If your property was placed in service before 1987, you will either use the Accelerated Cost Recovery System (ACRS) or the straight line/declining balance method.
How to Calculate Depreciation on Rental Property
Establish the basis of the property
Your basis in the property is the amount that was paid upon purchasing the home. According to the IRS, this can include the following:
- The sales tax when you bought the property (unless you deducted state and local general sales taxes on the Schedule A/Form 1040 as an itemized deduction)
- Freight charges needed to obtain the property
- Installation/testing charges
- Settlement costs: abstract fees, charges for installing utility services, recording fees, legal fees, surveys, transfer taxes, title insurance, back taxes or interest, sales commissions, etc.
The basis does not include fire insurance premiums, rent fees before closing, or charges related to loans (like mortgage insurance premiums, loan assumption fees, the cost of a credit report, or appraisal fees).
Determine cost of land vs. the rental
Since you can’t depreciate the cost of land, you’ll have to calculate the value of your home alone. To do this, use the fair market value of the property when you bought it or the assessed real estate tax values. If you bought your property for $140,000 but it’s now valued at $100,000 ($90,000 for the rental and $10,000 for the land), you can easily calculate the value of each by doing the following.
Value of the rental property:
$90,000 ÷ $100,000 = 0,9 = 90%
Value of the land:
$10,000 ÷ $100,000 = 0,1 = 10%
Calculate the basis of the rental
To find out the basis of the rental, just calculate 90% of $140,000. The result is $126,000.
In order to calculate the amount that can be depreciated each year, divide the basis by the recovery period. In this case, since residential rental property can be depreciated for 27.5 years, you would depreciate $4,589 per year.
If the home was not available for rent for the full year, divide the number of service months by 12 and multiply the result by $126,000.
Frequently Asked Questions
Here are some of the most frequently asked questions by owners regarding rental property depreciation:
Can you depreciate vacation rental property?
Yes! As long as you own the property, it has a determinable useful life, it’s expected to last more than a year, and it’s used for business purposes, you can go ahead and claim depreciation.
Can you depreciate the tile floors in a vacation rental?
Tile flooring, which is considered a permanent fixture, can be depreciated over the same useful life as your vacation rental property.
Can unused depreciation be deducted upon selling my vacation rental?
If you don’t claim depreciation while your property is on the rental market, you will be taxed with depreciation recapture. This basically means that the profits gained by selling your property will be taxed as ordinary income.
Can you depreciate furniture in a vacation rental property?
Yes, but furniture usually has a shorter useful life than the home itself so it is depreciated over a five-year period.
Can you depreciate exterior doors for vacation rentals?
Since doors are considered to be part of the structure of a rental, they can be depreciated over 27.5 years.
Do you have to claim depreciation on vacation rentals?
While you’re not required to claim depreciation, the IRS will charge a recapture tax regardless of whether you do or don’t.
There you have it! A complete run-down of the IRS’ rental property depreciation rules and regulations. We always suggest consulting a professional tax advisor to stay fully informed when claiming depreciation for your vacation rental property. If you have any questions, feel free to leave us a comment and we’ll get back to you shortly.