Homeowners cannot depreciate the value of their home. The IRS only allows investment real estate to be depreciated. Real estate depreciation is also applied only to improvements, the term used to classify buildings, landscaping, pavements and other artificial adjustments of raw land. The IRS does not allow the real estate investor to depreciate the value of the land.
The following are additional guidelines required for real estate depreciation deductions:
- Use. Only investment properties qualify for depreciation deductions. Investment property may include those used in a business, trade or industry; or the property must be income-producing, i.e. rental properties. However, properties that are held for resale (such as condo conversion units and homes intentionally built for resale) cannot be depreciated, because they would be considered inventory.
- Real property. All real property with qualified use is eligible for depreciation deductions. Thus, condominiums (which provide the owner only with air space but no land or building physical structures) may still be eligible for depreciation deduction if they are held for income or business.
- Mixed-use. Some properties are residences of the owner (thus non-depreciable) but contain business or rental portions. For example, someone may own a three-flat and live in one of the units; or a homeowner may have an office in his or her home. In such situations, only the prorated value of the business or rental portions may be depreciated.
- Defined useful life. Depreciation requires a defined useful life, and the IRS usually sets those "useful life" actuary tables. This explains why land cannot be depreciated, as it is nearly impossible to determine a constant and applicable useful life for land. Moreover, depreciation requires a useful life of at least one year. Useful life for real estate will be discussed in more detail in the "Calculating
Depreciation Deductions" section of this page.
- Capital investment. The depreciation amount will be based on the capital investment made by the investor into the property. If the investor bought real estate for $100,000, and the depreciable parts (building, driveway, etc.) were worth $75,000, the investor's depreciation deductions would be limited to $75,000.
- Improvements. In addition to the initial capital investment, all other capital investments made during the ownership of the property may also be depreciated. All real estate improvements (such as rehabs, upgrades and additions) can be depreciated; however, repairs and operating costs are not subject to depreciation . Depreciable improvements are any work that contributes to the property's value or extends the property's useful life.
- Start date. Real estate depreciation starts when the property is placed in service. It need not be occupied, just made available for occupancy or tenancy. Depreciation does not necessarily begin when the property is purchased or acquired. [For example, Frank owns and lives in a downtown condominium. He decides to move to the suburbs, but he wants to keep his condo and rent it out. When Frank moves out and markets the property for lease, it becomes an investment property that can be depreciated.]
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