How Depreciation Works
As we determined above, straight-line depreciation must be used for residential rental property and used over a 27.5 years.
Here is a quick example from The Balance Small Business:
Using an investment fourplex as an example, begin with a purchase price of $325,000. Assume the property will generate $15,192 a year in positive cash flow if all four units are rented out full time.
Now you can offset some of that income for tax purposes. You can depreciate the building by deducting out the value of the land and dividing the remainder, the building value, by 27.5 years to reach a figure for annual depreciation.
The depreciation calculation would look like this:
- Purchase price less land value equals building value
- Building value divided by 27.5 equals your annual allowable depreciation deduction
Assume that the value of the half-acre of land on which the fourplex sits is $80,000. The calculation would look like this:
- $325,000 less $80,000 equals $245,000 building value
- $245,000 divided by 27.5 years equals $8,909 a year in depreciation
Without taking any other property tax or mortgage interest deductions into account, you’ve already reduced your taxable rental income by $8,909 annually. And you didn’t have to spend any additional money to realize this deduction.