Are you planning to buy your first rental property? Read on and discover some of the crucial things which you should know as a landlord regarding the depreciation of that property.
Impact on Property Value
Depreciation offers rental property owners a way to reduce their tax obligation each year. This depreciation usually follows a schedule which has been designed to spread out the cost of the property over its entire expected service life. However, you should know that depreciation may affect how much tax you pay when you eventually decide to sell that property. This is because the value of the property is likely to be regarded as the value reflected in the depreciation schedule at the time you sell that property. Any income which exceeds that book value is therefore likely to attract a capital gains tax since you will be deemed to have earned more than the property was valued at after considering depreciation.
The Difference Between Expenses and Depreciation
It is also important for you to avoid making mistakes when you file your tax returns with respect to the rental property. Some inexperienced landlords may indicate some costs as expenses instead of reflecting them as costs which can benefit from depreciation. For example, repairing an HVAC system should be indicated under repairs while upgrading the HVAC system to a more efficient one qualifies for property depreciation since it is a capital expense that makes the property more usable. Avoid mixing up maintenance, repairs and capital expenses.
Effect of Bequeathing Your Property
Owners of rental properties should also consider long-term ways to work within the available legal processes in order to pay minimal taxes on those properties. As already mentioned, depreciation can be a double-edged sword because your capital gains tax obligation may be higher in case you sell your property after taking out several years' worth of depreciation. Consider the option of hanging onto your property so that it can be transferred to your heirs upon your demise. The beneficiary of that property may be permitted to take ownership at its value at the time of your death. Consequently, that person may prepare a new depreciation schedule and start taking the tax benefits associated with depreciation. The laws on this matter vary from one jurisdiction to another, so you should be certain that this approach will work before you include it in your plans.
Depreciation is a complicated matter which you may not be able to grasp as a first-time rental property owner. Work with tax services professionals so that they can explain all the relevant information upon which you will make the right tax decisions.