What is the Tax Basis of Property for Depreciation

The Tax Basis of your Property is used to calculate your Depreciation Deduction

Furniture, Appliances, and Equipment share the same method while Rental Property has a unique method. Use the Fair Market Value or Adjusted Basis of property when converted from personal residence to rental property.

The starting point to determine how much depreciation you can claim on a business asset is it’s tax basis.

What is the Tax Basis for Rental Property

To calculate how much depreciation you can claim on each house, you must first determine what proportion of it’s value is in land. Land is not depreciable. The Internal Revenue Service’s reasoning is that the land will maintain its value and therefore cannot be depreciated. Land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping.

Rental Property Tax Basis Example: Doug purchase a piece of rental property for $200,000. The tax assessor for the county assessed the value of the land to be $50,000 and the house to be $150,000. Houses are currently supposed to last 27.5 years so Doug would divide the $150,000 by 27.5 resulting in $5454.55. Since Doug is “losing” value in his rental property, the IRS will let him deduct this loss against his rental income as long as he qualifies as an active investor.

The government allows you to take a deduction each year for depreciation. The theory of depreciation is that your property gradually degrades over time. In the case of personal property, such as a car, this theory is true but real property is another story.

Generally, over time real property appreciates.

Conversion of Property from Personal Use to Rental Property
When you convert your personal residence to a rental property, you can begin to claim depreciation in the year you converted it to rental property because its use changed to an income producing use at that time. The tax basis of the rental property is the lower of the following:

      1.The Fair Market Value (FMV) of the property on the date of
      the change in use.
      2.The adjusted basis of the property is adjusted as follows:
    • -Increased by the cost of any permanent improvements or additions and other costs that must be added to the basis.
    • -Decreased by any deductions you claimed for casualty and theft losses and other items that reduced your basis.

Rental Property Tax Basis Example: In 2010 Matt Fuller purchased a home for $160,000. The value of the land was $30,000. Before he changed the property to rental use in 2014, Matt paid $20,000 for permanent improvements (a new furnace, a new roof, and a remodeled bathroom). Improvements are added to the tax basis of the home. Since land is not depreciable, Matt will include only the cost of the house when figuring the basis for depreciation. The adjusted basis of the house is $150,000 ($160,000 + $20,000 – $30,000). On the same date, his property has a FMV of $185,000 of which $40,000 was for land and $145,000 for the house. The basis for depreciation on the house is the FMV on the date of change ($145,000), because it is less than his adjusted basis ($150,000).

Assumed Debt
If you buy a property and assume (or buy subject to) an existing mortgage or other debt on the property, your basis includes the amount you pay for the property plus the amount of the assumed debt.

Tax Basis example: You make a $20,000 down payment on property and assume the seller’s mortgage of $120,000. Your total cost is $140,000, the cash you paid plus the mortgage your assumed.

Settlement Costs
The basis of real property also includes fees and charges you pay in addition to the purchase price. These generally are shown on your settlement statement and include the following:

  • Legal and recording fees
  • Abstract fees
  • Survey charges
  • Owner’s title insurance
  • Amount the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions

What is the Tax Basis for Furniture, Appliances, Equipment

The basis of these type of properties are based on the amount you paid for the property plus amounts paid for items such as sales tax, freight charges, and installation and testing fees.

Tax Basis Appliance Example 1: If you bought an appliance used in your rental property, a refrigerator for example, and paid $1,000 plus 7% sales tax as well as a $150 delivery charge, the tax basis would be $1,220 [($1,000 x 7%) + $150]. The $1,220 is the maximum amount that you could claim as depreciation over the life of the asset.

As with personal property, if you convert property from personal use to business use, you may depreciate it.

Tax Basis Appliance Example 2: Using the example above, assume Rich purchased a new refrigerator for $750 on April 1. The IRS allows a faster write off for personal property (computers, office furniture, washer, dryer, etc…) than for real property, such as a rental property. The IRS states that a refrigerator has a 7 year recovery period. The first year percentage for this type of property is 14.29%. Thus Rich would be allowed to deduct $107.18 ($750 x 14.29%).

This is a relatively simple explanation of depreciating personal property. What Depreciation methods apply to you? Visit our Depreciation Methods section to fully understand depreciation and how it relates to your real estate.

What is the Tax Basis of Inherited Property

Your tax basis in property your inherit from a decedent can be determined in several scenarios. What is the Tax Basis of Inherited Property? Get the facts about the tax basis of property via inheritance.

Adjusted Basis for Depreciation
Before you can figure the allowable depreciation, you may have to make certain adjustments (increases and decreases) to the tax basis of the property. The result of these adjustments to the basis is the adjusted basis.

Click here to learn more about the adjusted tax basis for your property.

If you can depreciate property you inherited, you generally must used the modified accelerated cost recovery system (MACRS) to determine depreciation.

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