Schedule E CPA tax accountant comments on Rental Real Estate Property Depreciation | Form 4562 Depreciation and Amortization

Schedule E CPAs routinely deal with rental real estate property depreciation. Sometimes I see landlord tax returns where the depreciation was incorrectly:

• Setup in the year of purchase on Schedule E, Supplemental Income and Loss.
• Presented on Form 4562, Depreciation and Amortization, for the current tax year.
• Presented on Form 4797, Sales of Business Property, in the year of sale.

Note that Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation, uses the same depreciation concepts as Schedule E. I’ll offer some tips I’ve learned over the years as a Schedule E CPA. I’ll stick with residential real estate in this post. But commercial rental property is similar, except the IRS life span is 40 years instead of 27.5 years.

What is rental property depreciation for the building and land for Schedule E?

Depreciation is a tax-deductible expense. Basic depreciation deducts the cost of the rental property building over the course of it’s expected usefulness, instead of deducting the entire cost in the year of purchase. For a depreciation deduction on Line 18 of Schedule E, the IRS requires residential real estate landlords to use a 27.5 year life span. There’s no rental property depreciation expense for land. Depreciation is usually the largest expense on Schedule E.

Rental real estate depreciation setup for Schedule E in the year of purchase

• Cost. Some landlords only use the purchase price of rental property as the cost.
  • Buyer settlement fees on the purchase HUD statement increase the cost.
  • Some other costs incurred before placing the rental property in service increase the “basis” of the rental property.
  • By not adding these additional expenses to the property basis, the landlord has more taxable gain, or less taxable loss when they prepare the rental property’s final Schedule E.
• You can’t depreciate the rental real estate land.
  • But track the land cost, it’s part the gain or loss calculation when you sell the rental property.
  • Landlords should have some type of justification for the cost of the land.
  • Lower land cost means additional depreciation expense.
  • Some types of rental real estate have no land value, e.g. condominiums.
• For the annual allowable depreciation expense divide the basis (cost) of the building by 27.5.
  • That’s the annual depreciation expense for Line 17 of Schedule E, except for the first and last partial years of rental property ownership.

Simplistic rental real estate depreciation example for Schedule E

• You buy a rental property for $250,000 on June 30th, 2014.
• You paid $8,000 of buyer settlement costs as shown on the HUD statement.
• You had $2,000 of legitimate expenses before trying to rent it out.
• You have some justification for valuing the rental property land at $30,000.

The amount of purchase cost you can use for depreciation is $230,000 ; 250 + 8 +2 - 30.

The annual depreciation expense for Schedule E, except for the first and last year, is $8,363; $230,000 / 27.5 years.

Depreciation expense for the first Schedule E is $4,182; $8363 / 2.

Current year depreciation on Form 4562, Depreciation and Amortization

Form 4562 is complex and covers multiple situations. The good news is that most tax software correctly produces it. But you should know the expected amount of rental property depreciation and check that figure on Form 4562.

Depreciation when you sell the rental property; Form 4797, Sales of Business Property

When you sell the rental property the IRS requires you to calculate the gain or loss on the transaction. Part of that calculation uses the accumulated depreciation for the rental property. Accumulated depreciation just means all the depreciation you claimed on all prior Schedule E(s), plus the current year depreciation.

“Here’s the biggest mistake I’ve seen a landlord make. He only calculated a $1,400 loss on a rental property foreclosure. The correct figure was a $91,000.”
- Gary Bode, Schedule E CPA tax accountant

Other rental property depreciation and amortization issues for Schedule E

• Appliances,for example,are reported separately from the actual rental property building.
  • Generally appliances use a seven-year life span. The depreciation isn’t straight line like the building. It’s accelerated, meaning you get to take a larger depreciation expense deduction on the first few Schedule E(s).
• Re-financing fees.
  • These use amortization, which is like depreciation but used for intangible expenses.

Sources of help for rental property depreciation:

• Publication 527, Residential Rental Property.
• Schedule E instructions.
• Form 4562 instructions.
• Form 4797 instructions.

I’m a Schedule E CPA with a virtual office

Distance isn’t a factor for utilizing our services. If you don’t have a local Schedule E CPA consider calling for a free consult (910) 399-2705.
Find me on Google+
Like me on Facebook