Rental Property Depreciation Rules & Refinancing

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When considering whether to refinance a property, you need to consider all factors to determine whether it is worth it to go through the process. Depreciating property is an important issue in property management and therefore might be something that could influence a refinancing decision. However, how a property is depreciated only has a little influence on the refinancing decision.

Property Depreciation

Depreciation is a means to calculate the annual “expense” associated with using the property and thus wearing it down. One important use of depreciation is with taxes, where annual depreciation is used to offset current-year tax liability while decreasing your overall tax basis, or your value in the building. According to the tax code, you can begin to depreciate rental property as soon as it is ready and available for use. “Ready and available” means the property is livable and available to rent. For tax purposes, you begin to calculate rental property depreciation by taking what you paid for the building, minus the value of the land, plus certain expenses such as legal costs incurred acquiring the building. Then you need to figure out the “useful life” for the property, which for residential rental property is 27.5 years and for nonresidential real property is 39 years. Then, using the tax code-mandated MACRS system, you can choose among a number of different depreciation strategies to calculate your annual depreciation expense, which can be applied against taxable income.

Refinancing Basics

Refinancing is generally a process used to refinance a loan so that the debtor can capitalize on better rates or financial conditions. What happens is that the debtor takes out a second mortgage for the amount of what he still owes on the first, using the underlying property as collateral. Using the proceeds from the second mortgage, he pays off the first. Refinancing is not something to be undertaken on a whim, as there are significant up-front costs and it takes significant time to complete. It is vital to consider whether the long-term benefits of a lower interest rate, shorter mortgage term or fixed-rate exceed the costs of refinancing.

Depreciation and Refinancing

Depreciation and refinancing do not purely interact, but elements of calculating depreciation could inform you of whether or not you should refinance. The primary considerations for determining whether you should refinance are the years remaining on your mortgage principal, your current balance, your current interest rate, your income tax rate, the years you expect to own the property and the fees associated with acquiring a new mortgage. Depreciation does not play a major role with those elements; although how quickly you depreciate the property could influence how long you plan to own the property. However, some advance calculations require you to calculate the rate at which you discount future costs, and tax benefits associated with the property, such as depreciation, could affect that amount. With those two caveats, however, depreciation does not directly influence refinancing.

Tips and Disclaimer

When refinancing, organization and documentation is key, so be sure to have all documents related to the original mortgage and the property organized and available for when you plan on negotiating the new mortgage. After acquiring the new mortgage, be sure to keep all related documentation for income tax purposes, especially if you plan on claiming deductions related to the refinancing.

When you do prepare your taxes, consult with a tax professional, such as a certified public accountant (CPA) or licensed attorney, as she can best address your individual needs. Keep your tax records for at least seven years, to protect against the possibility of future audits. Every effort has been made to ensure this article’s accuracy, but it is not intended to be legal advice.

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