Depreciation of Commercial Rental Property

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A new roof and structural improvements made to a small commercial building.
A new roof and structural improvements made to a small commercial building. (Image: lawcain/iStock/Getty Images)

Any building owned that is to be used for business, such as an office or a manufacturing plant, is commercial property. Tax law considers commercial property a depreciating asset, which means its value falls over time. You cannot write off major costs associated with commercial property in the year you incur those costs. Rather, you must deduct their value little by little each year until you have recovered the expenditure in full. The IRS sets a default recovery period of 39 years for most commercial buildings.

The Straight-Line Path to Deduction

Commercial buildings are depreciated on a straight-line basis over a specified recovery period. In most cases, that recovery period is 39 years. To calculate your annual deduction, simply divide your depreciable cost by the number of years in the recovery period. The result is the amount you can claim as a deduction from your taxable income each year. Certain tax-exempt properties such as farming and buildings brought into use pre-1987 use alternative depreciation systems. It’s best to take a tax accountant’s advice before depreciating a special case property.

What You Can Depreciate

Taxpayers can depreciate the value of commercial buildings and any improvements made to them. Anything that betters the property or adds to its value, such as a new roof, is an improvement. Repairs that simply keep the commercial property in operating condition are not improvements and you cannot depreciate them. Both the building and improvements are depreciable from the date you first place them in service. In most cases, this will be the date of purchase or installation. However, if the building is empty upon purchase, you do not bring it into service until you lease it to a tenant.

Sorting the Land from the Building

Land is not depreciable as its value does not materially deteriorate over time. Yet when you buy commercial real estate, you buy the land and the buildings on it as a single package. In order to depreciate the value of the commercial building, you must first divide the purchase price between the building and land. An accountant can do this for you in a way that satisfies the IRS. If you rent only part of your commercial property and use the rest for personal use, you can only depreciate the portion used for business.

Tenant Improvements Serve Less Time

Landlords typically make improvements to a rented commercial building every time a new tenant moves in. He likely will undo those improvements, and replace them with different improvements, when the tenant moves out at the end of his lease. In other words, tenant-specific improvements seldom last 39 years. The IRS recognizes this, and lets taxpayers depreciate non-structural tenant improvements over a 15-year accelerated schedule. Structural improvements, such as an addition, are depreciable on a standard 39-year schedule.

Recapturing Depreciation

Depreciation compensates property owners for the loss in value that commercial real estate suffers over time. For tax purposes, the value of a property at any given time is the price you paid for it minus the depreciation you claimed. It follows that, if you sell the property for more than its tax value, the property has not lost value like it was supposed to. In this scenario, the IRS will reclaim some of the deductions made on your tax return. At the time of publication, the IRS requires you to include any gain made on the sale as ordinary income on your tax return, up to the amount of the depreciation claimed before the time of sale.

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