TaxMama Rental Property Tax Law and Information


Capital Gains Tax on Rental Property

Rental Property Tax Deductions

Depreciation of Rental Property

  - No Time-Out
  - Low Income,
    High Interest
  - Depreciated or     Depreciable

Mixed-Use Residential Property

IRS Forms

Rental Property Depreciation

When dealing with residential real estate, when should you depreciate expenses, rather than deduct them? Here are some basic guidelines for correctly determining rental property depreciation.

The Basic Rules:

  • When depreciating real estate, you must use a 27˝ year life for residential rentals placed in service presently. And 39 years for non-residential property (offices, commercial space, warehouses – and office in home).

  • Appliances and rental furnishings are depreciated over 5 years, using MACRS rates.

  • Depreciation gets progressively more complicated, depending on what month you buy property, and how much property you buy. Read IRS Publication 946 for more details.

  • Cost Segregation Studies are used to determine the cost of the various components that go into a building or property. By determining costs for things like elevators, furnaces, fixtures, etc., you can increase your deductions in the early years dramatically. Instead of depreciating everything over 39 years, you may be able to depreciate a third of the property, or more, over 5-15 years. The studies are expensive – over $10,000. Typically, these studies are performed when buying or constructing a building. 

  • Bonus Tip: If you didn’t arrange for a cost segregation study when you bought the building, you can do it anytime. Then, with the new numbers, you can recompute the depreciation as it should have been if the study had been done when you bought the building. You can use Form 3115 and a special revenue procedure - 2004-11 to take the catch-up deductions in one year.



    No Time-Out

    Dear TaxMama,

    I have a question regarding a rental property that was properly depreciated, as well as the improvements that came afterwards for the years 1990 through 2001.

    From 2003 through 2005, the rental property was converted to the owner's primary residence. Now in 2005, the owners have sold the property in question.

    Must they pay tax on all the depreciation? I know that the exclusion applies on the sale for it being their home for the 2 out of the last 5 years, but is there ever a time limit on when you do not have to pay tax on that depreciation?

    Could they have held it longer ? Or would it not have mattered. This decision causes a difference of owing taxes equal to 8000+ dollars. Any loopholes we don't know about. Hope Tax Mama can help us.

    Thank You!

    ••• Tax Mama Replies •••

    Dear Patty,

    I don't know of any loopholes. Once that property has been used for business, the depreciation is taxable.

    But, hey, what are they complaining about? They get $500,000 of the gain tax-free.

    A pretty good deal, doncha think?

    Top of Page





    Low Income, High Interest

    Dear TaxMama,

    In March of this year (2004), I bought a house for $249,900. The mortgage payment on the house was about $2350.

    But I only make about $2270 a month from my job, gross. So, I moved into the house in March with a friend of mine.

    I paid a total of $750/month toward the mortgage, and he paid the rest of it (approx $1600/month) directly to me,not to the lender.

    I know that I can write off the interest on the mortgage. However, because of the amount of the mortgage payment ($2352) and the payment arrangement with my roommate, I am not sure what to do.

    Clearly, with my income, I do not pay anywhere near that amount in taxes, so I would end up writing off much more than I would owe.

    I do want to take advantage of the tax benefits of home ownership, but I don't want to get in trouble with the IRS.

    Should I write off the interest (or any portion of it)?

    Thank you for any and all advice.

    ••• Tax Mama Replies •••

    Hey David,

    You, my friend, have rental income.

    With housing prices so high these days, hardly anyone can afford a home in the city without a second income. So, if there's no spouse, there's usually a roommate.

    And when a roommate pays part of the costs, that usually ends up being rent.

    You'll need to file a Schedule E to report the rent that your roommate pays you.

    You'll need to find the appraisal of the property to get the value of the land and building.

    You will be depreciating the building using the residential depreciation tables. I explain how to use them - and how to report rentals in my book.

    When you fill out the form, split the property taxes and interest in half. Put half on your Schedule A, where you itemize your deductions. Put the other half on Schedule E.

    That should solve your problem about not having enough income to account for the high interest you're paying.

    But, there's more!

    In addition to deducting the property tax and interest on Schedule E, you'll also be able to deduct half the cost of utilities, insurance, gardener, cleaning and any other kind of maintenance or repairs. And if you did any major improvements or remodeling, you'll be able to depreciate half the cost of that, too.

    This will probably end up wiping out the income from the rents...without really reducing your personal income level so low as to attract attention.

    Clearly, I can't cover it all for you. You'll want to get a tax professional to prepare your tax return this year- at least the first year that you start doing this.

    Enjoy your new home.

    Top of Page



    Depreciated or Depreciable

    We have a rental unit that takes up about 30% of the entire square footage of our property. If we were to sell the house, would we have to pay taxes on the 30% of the profits?

    And if we were to stop renting, how long would it be before we could sell the house and not pay tax on the 30% profits (if the answer to the first question is yes)?

    And, what if we were renting the property, but not depreciating it? Would we still have to convert it to personal use before selling it to avoid the tax on 30% of the profits?

    Thank you,

    ••• Tax Mama Replies •••

    Hi Marilyn,

    Yes, the answer to question is a resounding "yes!"

    And if you stop renting it, you'd have to convert it back to personal use for at least 24 months before you can properly sell it with all the  non-taxable benefits of a personal residence (you know, that $500,000 non-taxable profit for couples).

    As to your last question, about not taking depreciation ... That's been tried. The rule is depreciated or depreciable. Even if you don't take it, you get charged as though you had. So, if you're using it as a rental, you have no choice.

    Top of Page



    Copyright 2015 - Present by Eva Rosenberg,
    The Net's best resource for small business and tax information.