Bifurcate depreciation? I first heard of the term when I attended one of Tom Lundstedt’s workshops on calculating the returns on investment property. (If you haven’t been, you should go. Or just order his CDs online. I don’t say this very often but he is worth every penny.) Anyway, it’s a $10 word to say separate.
I’ve referred to the 4 Benefits of owning rental property before but surprisingly I get very few comments or questions regarding depreciation. With tax season here, I thought I would hammer it home.
Pay very special attention to what I’m going to say next: Most rental property owners are improperly depreciating their income property because they are using a tax preparer who is unaware that you can bifurcate your depreciation. It may be costing you thousands!
There are 4 ways you should be breaking up the depreciation of your investment property;
- Land – no depreciation permitted.
- Building – depreciates over 27.5 years for residential or 39 years for commercial.
- Land Improvements – depreciates over 15 years. (driveway, landscaping, stairs, exterior lighting, etc.)
- Personal Property – depreciates over 5 years. (carpeting, appliances, etc.)
Hear Me! Most of you are only depreciating the Building! Stop doing that! We are entering the tax season and you need to know this so you can quiz your tax preparer. Still don’t believe me? Watch this example.
EXAMPLE 1: $200,000 duplex located in Overland Park, KS and the tax assessor says the land is worth $34,500. Depreciating the remaining number as the Building on your first year schedule will yield you a tax savings of $1,901. ($165,500 x 3.48% = $5759 x 33% tax bracket = $1,901)
EXAMPLE 2: $200,000 duplex located in Overland Park, KS and the tax assessor again says land is worth $34,500. A Cost Segregation Study shows you have a breakdown as follows;
- Building at $127,500.
- Land Improvements at $17,000.
- Personal Property at $21,000.
Now your formula works out to a tax savings of $3,131. That’s a $1,230 increase in saved taxes! ($127,500 x 3.48%) + ($17,000 x 5%) + ($21,000 x 20%) = $9,487 x 33% tax bracket = $3,131.
Please, I’m begging you (and I don’t generally do that unless you have KU basketball tickets I need) to do your homework on this and make sure your tax preparer does as well. After all, whether you depreciated your property correctly or incorrectly, you will have to pay the depreciation recapture when you sell. Unless, of course, you do a 1031 exchange. (So long as that is the smart thing to do. A whole other way to go is discussed here by my friend in San Diego.)