Do you really have to depreciate rental properties?September 27, 2012: 6:30 AM ET
We own three rental properties outright, but have not been depreciating them for tax purposes. An accountant tells us that IRS rules say we must take the depreciation. Is this true? — Steve R.
The short answer is yes, you must take the depreciation. Start by filing IRS Form 3115 to deduct previously unclaimed depreciation with your tax return. "I don't recommend waiting," says Janet Hagy, a CPA at Hagy & Associates in Austin, Tex. She explains that any delay can leave you vulnerable to an IRS audit or potential rule changes.
Filing takes some time, but Hagy says the process isn't difficult — and should result in a lower tax liability. When you claim depreciation for the first time you'll need to compute how much you should have been claiming each year, starting with the first year you rented each property. Going forward you will need to calculate the depreciation over the remaining useful life of the building. (The IRS defines a building's useful life as 27 ½ years for residential properties and 39 years for commercial properties, beginning when the property was first placed in service.)
If real estate is your primary business, your depreciation losses are fully deductible against all income. If not, your losses are known as "passive" and you can only deduct up to $25,000 against any income from the rentals. Losses of more than $25,000 can be carried over to the next year, but the deductions phase out if your modified adjusted gross income is between $100,000 and $150,000 (for both individuals and those who are married filing jointly). For more details, check out IRS Publication 527.
— Austin Kilham
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