Depreciating residential and commercial real estate allows landlords and business owners to deduct part of the cost of the property from their taxes each year. This tax deduction exists to compensate property owners for the deterioration and normal wear and tear of the property. Taxpayers take depreciation on several types of property, including furniture, vehicles and electronics used for business, but real estate typically provides the largest deduction.
To depreciate real estate, you must use the Modified Accelerated Cost Recovery System, or MACRS. This calculation system works for any real estate purchased in or after 1987. For residential real estate, such as a house or apartment building, you may depreciate the property for 27.5 years. You may depreciate commercial real estate, such as factories and office buildings, for 39 years using the MACRS method. Use IRS form 4562 to depreciate all your business property on your tax return.
Residential Rental Property
The IRS defines residential real estate as any building in which you receive at least 80 percent of the rent from residential units or dwellings. To calculate the depreciation, you must list the month and year you first used that building for business purposes on form 4562. Then list the basis, which is original cost you paid for the building minus the value of the land because you cannot depreciate land. This amount includes any mortgage, down payment or cash payment. Then look up the number on the MACRS 27.5-year table included in the 4562 instruction booklet that corresponds with the first month of rental use and the number of years of business use for the property. Multiply that number by the basis.
Commercial Real Estate
Commercial real estate, or nonresidential real estate, is defined as any real estate that is not classified as residential and has a useful life of more than 27.5 years. The depreciation procedure is very similar to the method for residential rental property. Using form 4562, you record the month and year you first used the property for business purposes and the basis of the property, not including the value of the land the building sits upon. Look on the MACRS chart for 39-year property and select the percentage that corresponds with the first month of business use and the number of years you have used the building. Then multiply that percentage by the basis for the property to determine the depreciation amount for the year.
If you have purchased any of the contents of the building for business use, such as appliances, machinery or office equipment, you can depreciate that property as well using the appropriate MACRS table. You may also depreciate building additions or deduct the cost of certain improvements, such as new kitchen cabinets for an apartment unit. You may calculate a depreciation deduction every year for your business property until you sell the property or you reach the end of its useful life, as determined by the IRS property classification table. In some tax years you can even choose to deduct the entire cost of property like office equipment in the purchase year rather than depreciating it over several years. See an accountant or tax adviser for more information.