How Segmented Depreciation Can Lower Your Tax Bill
When it comes to itemizing the depreciation of your rental property on your yearly tax return, there are a couple of options to consider. While the simpler (and standard) practice calls for landlords to simply divide the total value of a rental property by 27.5 years, taking roughly 1/27 of the property's value as a deduction each year, "segmented depreciation"---which splits the property into multiple assets that depreciate a varying rates---can ultimately save you money.
Modified Accelerated Cost Recovery System (MACRS) Explained
While the standard method of depreciation, also called "straight-line" depreciation, is certainly easier to understand, it has the disadvantage of not reflecting the reality when it comes to depreciating assets that last for a shorter period of time, such as carpets, refrigerators, and fencing.
In order to more accurately reflect this reality, the Internal Revenue Service developed the Modified Accelerated Cost Recovery System (MACRS) to account for the depreciation investment properties. Using this method, landlords can divide their rental properties in to several asset classes and depreciate them at varying rates. Under this system, assets such as appliances, carpeting, and furniture depreciating fully over a period of five years, allowing for much larger tax savings each year. At the end of the five-year period, you can replace these assets and start the short-term depreciation process all over again.
Standard Rates of Depreciation Under MACRS
Under MACRS General Depreciation System, rental property assets can be depreciated at the following rates:
- Appliances such as stoves and refrigerators: 5 years
- Fences, shrubbery, and driveways: 15 years
- Property that doesn't have a "specified class life, and is not part of any other class": 7 years
- Structural building elements such as furnaces, pipes, and actual construction materials: 27.5 years
Keep in Mind
When an income property is sold, the seller is required to recapture all depreciation at a rate of 25 percent. This means the IRS effectively assumes the owner took depreciation deductions and charges accordingly, so failure to take the deductions actually leads to a loss if the property is sold. Thus, it's in your best interest to maximize your depreciation deductions.
For more information about using MACRS to your advantage, talk to a tax professional.