On September 16, Senate approved the Small Business Jobs Act which is expected to help small businesses like property management companies, independent property managers in tax breaks from the government. Here is the detailed summary of the Small Business Jobs Act from the Senate website.

Provisions to Provide Access to Capital

100% Exclusion of Small Business Capital Gains.
Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and before January 1, 2011, the exclusion is increased to 75 percent. At the time of sale, however, 28% of the excluded gain will be treated as a tax preference item subject to the alternative minimum tax (AMT). Qualifying small business stock is from a C corporation whose gross assets do not exceed $50 million (including the proceeds received from the issuance of the stock) and who meets a specific active business requirement. The amount of gain eligible for the exclusion is limited to the greater of ten times the taxpayer’s basis in the stock or $10 million of gain from stock in that corporation. This bill would temporarily increase further the amount of the exclusion to 100 percent of the gain from the sale of qualifying small business stock that is acquired after the date of enactment in 2010 and held for more than five years. Additionally, the bill eliminates the AMT preference item attributable for that sale. This provision is estimated to cost $518 million over ten years.

General Business Credit Carried Back Five Years.
Under current law, a business’ unused general business credit may generally be carried back to offset taxes paid in the previous year, and the remaining amount may be carried forward for 20 years to offset future tax liabilities. This bill extends the one year carryback for general business credits to five years for certain small businesses. This applies to general business credits for those sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years. This provision is estimated to cost $107 million over ten years.

General Business Credit Not Subject to AMT.
Under the Alternative Minimum Tax (AMT), taxpayers may generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits may be used to offset AMT liability, such as the credit for small business employee health insurance expense. This bill allows certain small businesses to use all types of general business credits against their AMT. This applies to general business credits for those sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years. This provision is estimated to cost $977 million over ten years.

S Corp Holding Period.
Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built- in gain at the highest corporate rate of 35 percent. This holding period is reduced where the 7th taxable year in the holding period preceded the taxable year beginning in 2009 or 2010. This bill temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th taxable year in the holding period precedes the taxable year beginning in 2011. This provision is estimated to cost $70 million over ten years.

Increase Small Business Administration (SBA) Loan Limits.
This provision increases 7(a) loan limits from $2 million to $5 million, 504 loans from $1.5 million to $5.5 million, and microloans from $35,000 to $50,000. It also increases the government guarantee on 7(a) loan limits, while providing the elimination of borrower fees on 7(a) and 504 loans through December 31, 2010. It increases the 7(a) Express Loans from $300,000 to $1 million to increase working capital to small businesses. The package also includes Intermediary Lending Pilot program, which allows the SBA to make direct loans to eligible nonprofit lending intermediaries, in turn allowing them to make loans to new or growing small businesses. SBA has estimated that the loan increase would increase lending to small businesses by $5 billion in the first year.    This provision is estimated to cost $26 million over two years.

Extend Elimination of Small Business Administration (SBA) Loan Fees.
This provision extends the American Recovery and Reinvestment Act small business lending program that eliminates the fees normally charged for loans through the SBA 7(a) and 504 loan programs and increases the government guarantees on 7(a) loans from 75% to 90%. Since its creation, the program has supported over $26 billion in small business lending, which has helped to create or retain over 650,000 jobs. This provision was added in the substitute amendment introduced on July 21, 2010. This provision is estimated to cost $505 million over ten years.

State Small Business Credit Initiative (SSBCI).
The bill provides $1.5 billion in grants to States to support small business lending programs. States will apply for the funds to be used for approved programs that leverage private lenders to extend greater credit to small businesses and manufacturers. The program allows States to build upon successful models for state small business programs, including capital access, loan participation, collateral support, State-run venture capital, and credit guarantee programs. Funds are allocated to the States using formulas based on certain State employment and unemployment rate data. States have nine months to apply for the program. If the state does not apply, the largest municipalities of the states can apply. This provision was increased by $600 million in the substitute amendment introduced on July 21, 2010. This provision is estimated to cost $1.5 billion over ten years.

Small Business Lending Fund.
The bill authorizes the creation of the Small Business Lending Fund to provide Treasury with the ability to purchase preferred stock and other debt instruments from eligible financial institutions with less than $10 billion in total assets. Eligible institutions include insured depositories, bank and savings and loan holding companies, and certain community development loan funds. Eligible institutions with less than $1 billion in total assets can apply to receive investments of up to five percent of their risk-weighted assets. Eligible institutions between $1 billion and $10 billion in total assets can receive investments of up to three percent of risk-weighted assets. Participating institutions will pay a five percent dividend rate on the preferred stock, but this rate can be reduced to as low as one percent if a bank demonstrates a 10 percent increase in small business lending relative to a baseline set using the four quarters prior to enactment. The dividend rate is increased to seven percent after two years, if the bank does not increase its small business lending. To encourage timely repayment, the rate increases to nine percent after four and a half years. Treasury’s authority to make capital investments under the program is terminated one year after the date of enactment. This provision was added in the substitute amendment introduced on July 27, 2010.    This provision is estimated to raise $1.1 billion over ten years.

Require Information Reporting for Rental Property Expense Payments.
The bill requires persons receiving rental income from real property to file information returns to the IRS and to service providers reporting payments of $600 or more during the year for rental property expenses. In general, there is an exception for individuals renting their principal residences, including active members of the military, from the reporting requirements. This provision is estimated to raise $2.5 billion over ten years.

Source: finance.senate.gov

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Property Depreciation

Property depreciation is a deductible periodic accounting charge that represents the recovery of capital investment over the useful life of property used in a trade or business or other income producing activity. Land is not included, as it does not depreciate. For depreciable properties acquired prior to January 1, 1981, the principal methods for computing property depreciation are straight-line, declining balance and sum-of-the-years’ digits.

For depreciable properties acquired on and after January 1, 1981 and before August 1, 1986, property depreciation is computed under a method called accelerated cost recovery system (ACRS), permitting cost recovery over much shorter periods.

The Modified Accelerated Cost Recovery System (MACRS) must be used to depreciate property placed into service after 1986. Taxpayers need to consult their tax advisors for more information on any changes in the property depreciation schedules that have been effected since 1986.

Property depreciation for tax purposes is different from property depreciation for appraisal purposes. In appraisal practice, property depreciation is loss in value due to any cause, including functional obsolescence or physical deterioration. For income tax purposes, property depreciation is an annual deduction from taxable income in recognition of the fact an asset may become economically obsolete or wear out physically and the owner has the right to recover his investment.

Improvements to real property are depreciable for income tax purposes if they are used in business or held for the production of income and have a determinable life longer than one year. Even if a taxpayer does not take a deduction for property depreciation, the basis of the property is reduced by the amount of the property depreciation. Upon sale, the government charges the taxpayer with the full amount of property depreciation the taxpayer could have taken.

For more information about property depreciation check out rental property tax deductions.

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Tax Depreciation

Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the rental real estate property.

Most types of tangible property (except, land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable.  .

In order for a taxpayer to be allowed a depreciation deduction for a property, the property must meet all the following requirements:

1. The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases.

2. A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.

3. The property must have a determinable useful life of more than one year.

Even if a taxpayer meets the preceding requirements for a property, a taxpayer cannot depreciate the following property:

1. Property placed in service and disposed of in same year.

2. Equipment used to build capital improvements. A taxpayer must add otherwise allowable depreciation on the equipment during the period of construction to the basis of the improvements.

3. Certain term interests.

Depreciation begins when a taxpayer places property in service for use in rental business. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first.

A taxpayer must identify several items to ensure the proper depreciation of a property, including:

1. The depreciation method for the property

2. The class life of the asset

3, Whether the property is “Listed Property”

4. Whether the taxpayer elects to expense any portion of the asset

5. Whether the taxpayer qualifies for any “bonus” first year depreciation

6. The depreciable basis of the property

For more information about how to maximize depreciation expenses, CLICK HERE

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Rental Property Tax Deduction Depreciation

Depreciation expense is a very powerful tool for landlords, real estate investors to maximize their cash flow. To get a simple understanding of depreciation before reading the IRS information, CLICK HERE.

To get all the money saving tax tips on rental property depreciation expense, CLICK HERE. To maximize depreciation by segmenting rental property assets, read tip by CLICKING HERE.

You recover the cost of income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of the cost each year on your tax return.

Three basic factors determine how much depreciation you can deduct: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.

You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange.

You may have to use Form 4562 to figure and report your depreciation. See Which Forms To Use in chapter 3. Also see Publication 946.

Section 179 deduction. The section 179 deduction is a means of recovering part or all of the cost of certain qualifying property in the year you place the property in service. This deduction is not allowed for property used in connection with residential rental property. See chapter 2 of Publication 946.

Alternative minimum tax (AMT). Using a method of accelerated depreciation may affect your being subject to the alternative minimum tax. Accelerated depreciation allows you to deduct more depreciation earlier in the recovery period than you could deduct using a straight line method (same deduction each year).

The prescribed depreciation methods for rental real estate are not accelerated, so the depreciation deduction is not adjusted for the AMT. However, accelerated methods are generally used for other property connected with rental activities (for example, appliances and wall-to-wall carpeting).

To find out if you are subject to the AMT, see the Instructions for Form 6251, Alternative Minimum Tax—Individuals.

The Basics

The following section discusses the information you will need to have about the rental property and the decisions to be made before figuring your depreciation deduction.

What Rental Property Can Be Depreciated?

You can depreciate your property if it meets all the following requirements.

• You own the property.
• You use the property in your business or income-producing activity (such as rental property).
• The property has a determinable useful life.
• The property is expected to last more than 1 year.

Property you own. To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

Rented property. Generally, if you pay rent for property, you cannot depreciate that property. Usually, only the owner can depreciate it. However, if you make permanent improvements to leased property, you may be able to depreciate the improvements. See Additions or improvements to property, later in this chapter, under Recovery Periods Under GDS.

Cooperative apartments. If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can deduct depreciation on your stock in the corporation. See chapter 4.

Property having a determinable useful life. To be depreciable, your property must have a determinable useful life. This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

What Rental Property Cannot Be Depreciated?

Certain property cannot be depreciated. This includes land and certain excepted property.

Land. You cannot depreciate the cost of land because land generally does not wear out, become obsolete, or get used up. But if it does, the loss is accounted for upon disposition. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated.

Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. These costs must be so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property.

Example.

You built a new house to use as a rental and paid for grading, clearing, seeding, and planting bushes and trees. Some of the bushes and trees were planted right next to the house, while others were planted around the outer border of the lot. If you replace the house, you would have to destroy the bushes and trees right next to it. These bushes and trees are closely associated with the house, so they have a determinable useful life. Therefore, you can depreciate them. Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them.

Excepted property. Even if the property meets all the requirements listed on this page under What Rental Property Can Be Depreciated, you cannot depreciate the following property.

• Property placed in service and disposed of (or taken out of business use) in the same year.
• Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements.

For more information, see Publication 946, chapter 1.

When Does Depreciation Begin and End?

You begin to depreciate your rental property when you place it in service for the production of income. You stop depreciating it either when you have fully recovered your cost or other basis, or when you retire it from service, whichever happens first.

Placed in Service

You place property in service in a rental activity when it is ready and available for a specific use in that activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example 1.

On November 22 of last year, you purchased a dishwasher for your rental property. The appliance was delivered on December 7, but was not installed and ready for use until January 3 of this year. Because the dishwasher was not ready for use last year, it is not considered placed in service until this year.

If the appliance had been installed and ready for use when it was delivered in December of last year, it would have been considered placed in service in December, even if it was not actually used until this year.

Example 2.

On April 6, you purchased a house to use as residential rental property. You made extensive repairs to the house and had it ready for rent on July 5. You began to advertise the house for rent in July and actually rented it beginning September 1. The house is considered placed in service in July when it was ready and available for rent. You can begin to depreciate the house in July.

Example 3.

You moved from your home in July. During August and September you made several repairs to the house. On October 1, you listed the property for rent with a real estate company, which rented it on December 1. The property is considered placed in service on October 1, the date when it was available for rent.

Conversion to business use. If you place property in service in a personal activity, you cannot claim depreciation. However, if you change the property’s use to business or the production of income, you can begin to depreciate it at the time of the change. You place the property in service for business or income-producing use on the date of the change.

Example.

You bought a home and used it as your personal home several years before you converted it to rental property. Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. You can begin to claim depreciation in the year you converted it to rental property because at that time its use changed to the production of income.

Idle Property

Continue to claim a deduction for depreciation on property used in your rental activity even if it is temporarily idle (not in use). For example, if you must make repairs after a tenant moves out, you still depreciate the rental property during the time it is not available for rent.

Cost or Other Basis Fully Recovered

You must stop depreciating property when the total of your yearly depreciation deductions equals your cost or other basis of your property. For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you did not claim it. See Basis of Depreciable Property on this page.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

• You sell or exchange the property.
• You convert the property to personal use.
• You abandon the property.
• The property is destroyed.

Depreciation Methods

Generally, you must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental property placed in service after 1986.

If you placed rental property in service before 1987, you are using one of the following methods.

• ACRS (Accelerated Cost Recovery System) for property placed in service after 1980 but before 1987.
• Straight line or declining balance method over the useful life of property placed in service before 1981.

Rental property placed in service before 2009. Continue to use the same method of figuring depreciation that you used in the past.

Use of real property changed. Generally, you must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. This includes your residence that you changed to rental use. See Property Owned or Used in 1986 in Publication 946, chapter 1, for those situations in which MACRS is not allowed.

Improvements made after 1986. Treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. Therefore, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. For more information about improvements, see Additions or improvements to property, later in this chapter under Recovery Periods Under GDS.

This publication discusses MACRS depreciation only. If you need information about depreciating property placed in service before 1987, see Publication 534.

Basis of Depreciable Property

The basis of property used in a rental activity is generally its adjusted basis when you place it in service in that activity. This is its cost or other basis when you acquired it, adjusted for certain items occurring before you place it in service in the rental activity.

If you depreciate your property under MACRS, you may also have to reduce your basis by certain deductions and credits with respect to the property.

Basis and adjusted basis are explained in the following discussions.

If you used the property for personal purposes before changing it to rental use, its basis for depreciation is the lesser of its adjusted basis or its fair market value when you change it to rental use. See Basis of Property Changed to Rental Use in chapter 4.

Cost Basis

The basis of property you buy is usually its cost. The cost is the amount you pay for it in cash, in debt obligation, in other property, or in services. Your cost also includes amounts you pay for:

• Sales tax charged on the purchase (but see Exception below),
• Freight charges to obtain the property, and
• Installation and testing charges.

Exception. if you deducted state and local general sales taxes as an itemized deduction on Schedule A (Form 1040), do not include those sales taxes as part of your cost basis. Such taxes were deductible before 1987 and after 2003.

Loans with low or no interest. If you buy property on any time-payment plan that charges little or no interest, the basis of your property is your stated purchase price, less the amount considered to be unstated interest. See Unstated Interest and Original Issue Discount (OID) in Publication 537, Installment Sales.

Real property. If you buy real property, such as a building and land, certain fees and other expenses you pay are part of your cost basis in the property.

Real estate taxes. If you buy real property and agree to pay real estate taxes on it that were owed by the seller and the seller does not reimburse you, the taxes you pay are treated as part of your basis in the property. You cannot deduct them as taxes paid.

If you reimburse the seller for real estate taxes the seller paid for you, you can usually deduct that amount. Do not include that amount in your basis in the property.

Settlement fees and other costs. The following settlement fees and closing costs that are for buying the property are part of your basis in the property.

• Abstract fees.
• Charges for installing utility services.
• Legal fees.
• Recording fees.
• Surveys.
• Transfer taxes.
• Title insurance.
• Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

The following are settlement fees and closing costs you cannot include in your basis in the property.

1. Fire insurance premiums.
2. Rent or other charges relating to occupancy of the property before closing.
3. Charges connected with getting or refinancing a loan, such as:
   1. Points (discount points, loan origination fees),
   2. Mortgage insurance premiums,
   3. Loan assumption fees,
   4. Cost of a credit report, and
   5. Fees for an appraisal required by a lender.

Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Assumption of a mortgage. If you buy property and become liable for an existing mortgage on the property, your basis is the amount you pay for the property plus the amount remaining to be paid on the mortgage.

Example.

You buy a building for $60,000 cash and assume a mortgage of $240,000 on it. Your basis is $300,000.

Separating cost of land and buildings. If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it.

If you are not certain of the fair market values of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes.

Example.

You buy a house and land for $200,000. The purchase contract does not specify how much of the purchase price is for the house and how much is for the land.

The latest real estate tax assessment on the property was based on an assessed value of $160,000, of which $136,000 was for the house and $24,000 was for the land.

You can allocate 85% ($136,000 ÷ $160,000) of the purchase price to the house and 15% ($24,000 ÷ $160,000) of the purchase price to the land.

Your basis in the house is $170,000 (85% of $200,000) and your basis in the land is $30,000 (15% of $200,000).

Basis Other Than Cost

You cannot use cost as a basis for property that you received:

• In return for services you performed,
• In an exchange for other property,
• As a gift,
• From your spouse, or from your former spouse as the result of a divorce, or
• As an inheritance.

If you received property in one of these ways, see Publication 551 for information on how to figure your basis.

Adjusted Basis

To figure your property’s basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service for business or the production of income. The result of these adjustments to the basis is the adjusted basis.

Increases to basis. You must increase the basis of any property by the cost of all items properly added to a capital account. These include the following.

• The cost of any additions or improvements made before placing your property into service as a rental that have a useful life of more than 1 year.
• Amounts spent after a casualty to restore the damaged property.
• The cost of extending utility service lines to the property.
• Legal fees, such as the cost of defending and perfecting title, or settling zoning issues.

Additions or improvements. Add to the basis of your property the amount an addition or improvement actually cost you, including any amount you borrowed to make the addition or improvement. This includes all direct costs, such as material and labor, but not your own labor. It also includes all expenses related to the addition or improvement.

For example, if you had an architect draw up plans for remodeling your property, the architect’s fee is a part of the cost of the remodeling. Or, if you had your lot surveyed to put up a fence, the cost of the survey is a part of the cost of the fence.

Keep separate accounts for depreciable additions or improvements made after you place the property in service in your rental activity. For information on depreciating additions or improvements, see Additions or improvements to property, later in this chapter, under Recovery Periods Under GDS.

The cost of landscaping improvements is usually treated as an addition to the basis of the land, which is not depreciable. However, see What Rental Property Cannot Be Depreciated, earlier.

Assessments for local improvements. Assessments for items which tend to increase the value of property, such as streets and sidewalks, must be added to the basis of the property. For example, if your city installs curbing on the street in front of your house, and assesses you and your neighbors for its cost, you must add the assessment to the basis of your property. Also add the cost of legal fees paid to obtain a decrease in an assessment levied against property to pay for local improvements. You cannot deduct these items as taxes or depreciate them.

However, you can deduct as taxes, charges or assessments for maintenance, repairs, or interest charges related to the improvements. Do not add them to your basis in the property.

Deducting vs. capitalizing costs. Do not add to your basis costs you can deduct as current expenses. However, there are certain costs you can choose either to deduct or to capitalize. If you capitalize these costs, include them in your basis. If you deduct them, do not include them in your basis.

The costs you may be able to choose to deduct or capitalize include carrying charges, such as interest and taxes, that you must pay to own property.

For more information about deducting or capitalizing costs and how to make the election, see Carrying Charges in Publication 535, chapter 7.

Decreases to basis. You must decrease the basis of your property by any items that represent a return of your cost. These include the following.

• Insurance or other payment you receive as the result of a casualty or theft loss.
• Casualty loss not covered by insurance for which you took a deduction.
• Amount(s) you receive for granting an easement.
• Residential energy credit you were allowed before 1986, or after 2005, if you added the cost of the energy items to the basis of your home.
• Exclusion from income of subsidies for energy conservation measures.
• Special depreciation allowance claimed on qualified property.
• Depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. If you did not deduct enough or deducted too much in any year, see Depreciation under Decreases to Basis in Publication 551.

If your rental property was previously used as your main home, you must also decrease the basis by the following.

• Gain you postponed from the sale of your main home before May 7, 1997, if the replacement home was converted to your rental property.
• District of Columbia first-time homebuyer credit allowed on the purchase of your main home after August 4, 1997.
• Amount of qualified principal residence indebtedness discharged on or after January 1, 2007.

Claiming the Special Depreciation Allowance

For 2009, your residential rental property may qualify for a special 30% or 50% depreciation allowance. This allowance is figured before you figure your regular depreciation deduction.

Among other qualifications, this property must be located in the New York Liberty Zone, the Gulf Opportunity Zone, the Kansas disaster area, or other federally declared disaster areas. See Publication 946, chapter 3, for details. Also see the Instructions for Form 4562, Line 14.

If you qualify for, but choose not to take, a special depreciation allowance, you must attach a statement to your return. The details of this election are in Publication 946, chapter 3, and the Instructions for Form 4562, Line 14.

MACRS Depreciation

Most business and investment property placed in service after 1986 is depreciated using MACRS.

This section explains how to determine which MACRS depreciation system applies to your property. It also discusses other information you need to know before you can figure depreciation under MACRS. This information includes the property’s:

• Recovery class,
• Applicable recovery period,
• Convention,
• Placed-in-service date,
• Basis for depreciation, and
• Depreciation method.

Depreciation Systems

MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, you must use GDS for property used in most rental activities, unless you elect ADS.

Excluded Property

You cannot use MACRS for certain personal property (such as furniture or appliances) placed in service in your rental property in 2009 if it had been previously placed in service before 1987 when MACRS became effective.

Generally, personal property is excluded from MACRS if you (or a person related to you) owned or used it in 1986 or if your tenant is a person (or someone related to the person) who owned or used it in 1986. However, the property is not excluded if your 2009 deduction under MACRS (using a half-year convention) is less than the deduction you would have under ACRS. For more information, see What Method Can You Use To Depreciate Your Property? in Publication 946, chapter 1.

Electing ADS

If you choose, you can use the ADS method for most property. Under ADS, you use the straight line method of depreciation.

The election of ADS for one item in a class of property generally applies to all property in that class that is placed in service during the tax year of the election. However, the election applies on a property-by-property basis for residential rental property and nonresidential real property.

For property placed in service during 2009, you elect to use ADS by entering the depreciation on Form 4562, Part III, line 20.

Once you elect to use ADS, you cannot change your election.

Property Classes Under GDS

Each item of property that can be depreciated under MACRS is assigned to a property class, determined by its class life. The property class generally determines the depreciation method, recovery period, and convention. The property classes under GDS are:

• 3-year property,
• 5-year property,
• 7-year property,
• 10-year property,
• 15-year property,
• 20-year property,
• Nonresidential real property, and
• Residential rental property.

Under MACRS, property that you placed in service during 2009 in your rental activities generally falls into one of the following classes.

• 5-year property. This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks.

This class also includes appliances, carpeting, furniture, etc., used in a residential rental real estate activity.

Depreciation on automobiles, certain computers, and cellular telephones is limited. See chapter 5 of Publication 946.

• 7-year property. This class includes office furniture and equipment (desks, file cabinets, etc.). This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.
• 15-year property. This class includes roads, fences, and shrubbery (if depreciable).
• Residential rental property. This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in.

The other property classes do not generally apply to property used in rental activities. These classes are not discussed in this publication. See Publication 946 for more information.

Recovery Periods Under GDS

The recovery period of property is the number of years over which you recover its cost or other basis. The recovery periods are generally longer under ADS than GDS.

The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class.

Class lives and recovery periods for most assets are listed in Appendix B of Publication 946. See Table 2-1 for recovery periods of property commonly used in residential rental activities.

Qualified Indian reservation property. Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations. For more information, see chapter 4 of Publication 946.

Additions or improvements to property. Treat additions or improvements you make to your depreciable rental property as separate property items for depreciation purposes.

The property class and recovery period of the addition or improvement is the one that would apply to the original property if you had placed it in service at the same time as the addition or improvement.

The recovery period for an addition or improvement to property begins on the later of:

• The date the addition or improvement is placed in service, or
• The date the property to which the addition or improvement was made is placed in service.

Example.

You own a residential rental house that you have been renting since 1986 and depreciating under ACRS. You built an addition onto the house and placed it in service in 2009. You must use MACRS for the addition. Under GDS, the addition is depreciated as residential rental property over 27.5 years.

Table 2-1.MACRS Recovery Periods for Property Used in Rental Activities

Conventions

A convention is a method established under MACRS to set the beginning and end of the recovery period. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property.

Mid-month convention. A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month.

Mid-quarter convention. A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year.

Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter.

Example.

During the tax year, Tom Martin purchased the following items to use in his rental property. He elects not to claim the special depreciation allowance, discussed earlier.

• A dishwasher for $400 that he placed in service in January.
• Used furniture for $100 that he placed in service in September.
• A refrigerator for $800 that he placed in service in October.

Tom uses the calendar year as his tax year. The total basis of all property placed in service that year is $1,300. The $800 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $520 (40% × $1,300). Tom must use the mid-quarter convention instead of the half-year convention for all three items.

Half-year convention. The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year.

If this convention applies, you deduct a half year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period.

Figuring Your Depreciation Deduction

You can figure your MACRS depreciation deduction in one of two ways. The deduction is substantially the same both ways. You can either:

• Actually compute the deduction using the depreciation method and convention that apply over the recovery period of the property, or
• Use the percentage from the MACRS percentage tables, shown later.

In this publication we will use the percentage tables. For instructions on how to compute the deduction, see chapter 4 of Publication 946.

Residential rental property. You must use the straight line method and a mid-month convention for residential rental property. In the first year that you claim depreciation for residential rental property, you can claim depreciation only for the number of months the property is in use, and you must use the mid-month convention (explained under Conventions, earlier on this page).

5-, 7-, or 15-year property. For property in the 5- or 7-year class, use the 200% declining balance method and a half-year convention. However, in limited cases you must use the mid-quarter convention, if it applies. For property in the 15-year class, use the 150% declining balance method and a half-year convention.

You can also choose to use the 150% declining balance method for property in the 5- or 7-year class. The choice to use the 150% method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You make this election on Form 4562. In Part III, column (f), enter “150 DB.” Once you make this election, you cannot change to another method.

If you use either the 200% or 150% declining balance method, you figure your deduction using the straight line method in the first tax year that the straight line method gives you an equal or larger deduction.

You can also choose to use the straight line method with a half-year or mid-quarter convention for 5-, 7-, or 15-year property. The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You elect the straight line method on Form 4562. In Part III, column (f), enter “S/L.” Once you make this election, you cannot change to another method.

MACRS Percentage Tables

You can use the percentages in Table 2-2 (on the next page) to compute annual depreciation under MACRS. The tables show the percentages for the first few years or until the change to the straight line method is made. See Appendix A of Publication 946 for complete tables. The percentages in Tables 2-2a, 2-2b, and 2-2c make the change from declining balance to straight line in the year that straight line will give a larger deduction.

If you elect to use the straight line method for 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use the tables in Appendix A of Publication 946.

How to use the percentage tables. You must apply the table rates to your property’s unadjusted basis (defined below) each year of the recovery period.

Once you begin using a percentage table to figure depreciation, you must continue to use it for the entire recovery period unless there is an adjustment to the basis of your property for a reason other than:

1. Depreciation allowed or allowable, or
2. An addition or improvement that is depreciated as a separate item of property.

If there is an adjustment for any reason other than (1) or (2), for example, because of a deductible casualty loss, you can no longer use the table. For the year of the adjustment and for the remaining recovery period, figure depreciation using the property’s adjusted basis at the end of the year and the appropriate depreciation method, as explained on this page under Figuring Your Depreciation Deduction. See Figuring the Deduction Without Using the Tables in Publication 946, chapter 4.

Unadjusted basis. This is the same basis you would use to figure gain on a sale (see Basis of Depreciable Property earlier), but without reducing your original basis by any MACRS depreciation taken in earlier years.

However, you do reduce your original basis by other amounts claimed on the property, including:

• Any amortization,
• Any section 179 deduction, and
• Any special depreciation allowance.

For more information, see Publication 946, chapter 4.

Table 2-2

Tables 2-2a, 2-2b, and 2-2c. The percentages in these tables take into account the half-year and mid-quarter conventions. Use Table 2-2a for 5-year property, Table 2-2b for 7-year property, and Table 2-2c for 15-year property. Use the percentage in the second column (half-year convention) unless you are required to use the mid-quarter convention (explained earlier). If you must use the mid-quarter convention, use the column that corresponds to the calendar year quarter in which you placed the property in service.

Example 1.

You purchased a stove and refrigerator and placed them in service in June. Your basis in the stove is $600 and your basis in the refrigerator is $1,000. Both are 5-year property. Using the half-year convention column in Table 2-2a, the depreciation percentage for Year 1 is 20%. For that year your depreciation deduction is $120 ($600 × .20) for the stove and $200 ($1,000 × .20) for the refrigerator.

For Year 2, the depreciation percentage is 32%. That year’s depreciation deduction will be $192 ($600 × .32) for the stove and $320 ($1,000 × .32) for the refrigerator.

Example 2.

Assume the same facts as in Example 1, except you buy the refrigerator in October instead of June. Since the refrigerator was placed in service in the last 3 months of the tax year, and its basis ($1,000) is more than 40% of the total basis of all property placed in service during the year ($1,600 × .40 = $640), you are required to use the mid-quarter convention to figure depreciation on both the stove and refrigerator.

Because you placed the refrigerator in service in October, you use the fourth quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 5%. Your depreciation deduction for the refrigerator is $50 ($1,000 × .05).

Because you placed the stove in service in June, you use the second quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 25%. For that year, your depreciation deduction for the stove is $150 ($600 × .25).

Table 2-2d. Use this table for residential rental property. Find the row for the month that you placed the property in service. Use the percentages listed for that month to figure your depreciation deduction. The mid-month convention is taken into account in the percentages shown in the table. Continue to use the same row (month) under the column for the appropriate year.

Example.

You purchased a single family rental house for $185,000 and placed it in service on February 8. The sales contract showed that the building cost $160,000 and the land cost $25,000. Your basis for depreciation is its original cost, $160,000. Using Table 2-2d, you find that the percentage for property placed in service in February of Year 1 is 3.182%. That year’s depreciation deduction is $5,091 ($160,000 × .03182).

Figuring MACRS Depreciation Under ADS

Table 2-1, earlier, shows the ADS recovery periods for property used in rental activities.

See Appendix B in Publication 946 for other property. If your property is not listed in Appendix B, it is considered to have no class life. Under ADS, personal property with no class life is depreciated using a recovery period of 12 years.

Use the mid-month convention for residential rental property and nonresidential real property. For all other property, use the half-year or mid-quarter convention, as appropriate.

Claiming the Correct Amount of Depreciation

You should claim the correct amount of depreciation each tax year. If you did not claim all the depreciation you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. For more information, see Depreciation under Decreases to Basis in Publication 551.

If you deducted an incorrect amount of depreciation for property in any year, you may be able to make a correction by filing Form 1040X, Amended U.S. Individual Income Tax Return. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation.

Filing an amended return. You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year.
• You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003.
• You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003.

Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return for the property used in your rental activity. This also occurs when you use the same impermissible method of determining depreciation (for example, using the wrong MACRS recovery period) in two or more consecutively filed tax returns.

If an amended return is allowed, you must file it by the later of the following dates.

• 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. A return filed before an unextended due date is considered filed on that due date.
• 2 years from the time you paid your tax for that year.

Changing your accounting method. To change your accounting method, you generally must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some instances, that consent is automatic. For more information, see Changing Your Accounting Method in Publication 946, chapter 1.

Source:  IRS 2009 Publication 527

This blog post for Real Estate Professionals, Investors, Landlord, Property Manager, and Property Management Companies is brought to you by SimplifyEm Pay Rent Online and Property Management Software

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A wise man once told the world that there are only two certainties in life – death and taxes. It doesn’t take a genius to figure that one out (sorry Benjamin Franklin).

Some people will unknowingly travel a great distance to elude one or the other. One of those individuals is my friend Bob.

Bob’s almost retired, and because Bob is a “small” real estate investor, he tries to save money whenever he can. That’s why Bob mows the lawns, manages the properties, and balances the books by himself.

An even wiser man told me a few years ago that there are three certainties that I should know about – death, taxes, and the regret that I would live with for the rest of my life if I didn’t maximize depreciation on my rental properties…

I thought I would regret the 25% depreciation recapture tax if I ever decided to sell my rentals. That’s because Bob used to say to me “all that depreciation stuff is a waste of time. You have to recapture the deductions at 25 percent anyway…”

Being a new investor back then, I wasn’t exactly sure what Bob was talking about, so I went and talked to my tax advisor. He explained to me that when I purchase an income producing asset, like an investment property for my rental business – I don’t get to immediately write off the acquisition cost of the asset. Instead, the cost of my asset must be recovered over the useful life of the asset. This is called depreciation, and the IRS has ruled that residential rental property is depreciable over 27.5 years. Depreciation is a phantom paper expense that reduces your taxable profit.

I bought a single family home for $165k, and it generated $12k from rent that year. I had $8k of expense deductions, so it appears I should have claimed $4k in rental income and paid online taxes on it. However, this rental property gave me a depreciation deduction of $6k ($165k/27.5 years), which allowed me to claim a $2k rental loss that I could take against my regular income. At a 28% federal tax rate, the additional depreciation deduction was allowing me to pay $1,680 less in taxes (28% * $6k less income). Eventually, I came to realize the benefit that depreciation was providing me – it was allowing me to owe less in taxes, even when I was making more profit.

Soon enough, I learned about separating my assets and segmenting my deductions, and it was saving me thousands of dollars more. People normally depreciate their properties using a straight-line deduction over 27.5 years. However, residential properties have shorter-life assets – like a refrigerator or a fence – that can be separated and depreciated sooner over 5 or 15 years. I identify these assets and depreciate them separately so I can take the deductions sooner. With the accelerated, higher deductions, I can reduce my tax liability and save thousands of dollars.

Using straight-line depreciation on a $275k property can yield a $10k yearly depreciation deduction, so $50k can be deducted over five years. However, the property might have $50k in 5 year assets (carpets, appliances, drapes, etc…) and $25k in 15 year assets (driveway, fence, patio, etc…). Depreciating these assets separately according to IRS class lives allows nearly $100k to be deducted over the first five years – almost twice the deduction from straight-line.

Three years later, I wish I could travel back in time to let Bob know that I disagree with him. Back then, I vaguely understood that the accumulated depreciation deductions would get recaptured and taxed at a rate of 25% upon the sale. This was Bob’s main concern, and he was worried about owing back a lot of money on the depreciation deductions he would have taken, if he ever sold his rental property.

The reality is that the IRS wants us to take timely depreciation deductions – that’s why they created the rule. They even know some of us want to separate assets and segment deductions according to useful class lives – that’s why they ruled on depreciable lives for common assets found in properties. If we ever sell our rental properties, the IRS will recapture the depreciation that we should have deducted – even if we never took any depreciation deductions! The important thing to learn here is that the IRS says we have to depreciate, and if we don’t, we lose the tax benefit – so we might as well follow the rules and use them to our advantage by maximizing depreciation deductions, right?

With straight-line depreciation, we get the same deduction every year – meaning our depreciation deduction in year 3 is the same as the depreciation deduction in year 23. Accelerating deductions simply means we deduct more now instead of later. Having a larger deduction now means we also have a smaller tax bill now – so why don’t people do it?

Generally speaking, there are two main reasons why investors might use straight-line depreciation. One is passive-activity limitations. Taxpayers with an AGI above $150k cannot deduct any rental losses against their wage income – the loss must be carried forward until it can be offset with future rental income. Therefore, a high income taxpayer who already has a rental loss carryover receives no benefit from the larger deductions. Their rental losses must be offset with future rental income. A real estate investor can avoid this limitation by materially participating in the rental activity and becoming a “real estate professional.” Fear of depreciation recapture is another reason. When an investor sells their rental property, they will have to recapture depreciation deductions at a rate of 25% – so they would rather not accelerate the portion that might be recaptured.

Time Value of Money
Everyone has heard the phrase “a dollar today is worth more than a dollar ten years from now.” So if a dollar paid today is worth more than a dollar paid in the future, why choose to give up the dollar now? The longer you delay paying taxes, the more money you can invest wisely and keep in your pockets. And of course you can avoid the recapture altogether and defer your taxes indefinitely using a 1031 exchange.

According to IRS data, Bob and 78% of all taxpayers in America don’t segment their assets to maximize deductions. Many do not know about the opportunity, some may think it’s too complicated, and others do not see the benefit. Investors should educate themselves on accelerated depreciation, and understand the opportunities that are available to them. A Cost Segregation guide is available on the IRS website. You should discuss the pros and cons with your tax advisor, and make an informed decision.

I know now that the wise man was speaking the truth to me, and I certainly regret missing out on my own depreciation deductions.

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Save thousands of dollars by segmenting depreciation deductions. Identify your property’s short life assets so you can depreciate them sooner, and by accelerating your deductions you can save money on taxes.

People normally depreciate their properties using a straight-line deduction over 27.5 years, so for a property with a $275,000 basis, you can have a yearly depreciation deduction of $10k for 27.5 years.

Usually a property has shorter-life assets, like a refrigerator or a fence that can be separated and depreciated sooner over 5 or 15 years. When you identify those assets and depreciate them separately, you are taking deductions sooner. With the accelerated, higher deductions, you can offset your tax liability and save thousands of dollars, especially if you are already at a high income bracket.

For example, say the $275k property has 50k in 5 year assets (carpets, appliances, drapes, etc…) and 25k in 15 year assets (driveway, fence, patio, etc…). By depreciating these amounts separately, instead of deducting 50k over the first 5 years, you can deduct almost 100k. This can save you nearly $20,000 in federal and state taxes.

For a more detailed explanation and simple guided assistance, try using www.DepreciateEm.com to segment your depreciation deductions.

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By maximizing depreciation deductions, you minimize taxable liability and save money on taxes. Since you cannot immediately write-off the purchase cost of investment property, you must deduct the acquisition cost over the life of the property using depreciation.

Most rental owners are able to turn profits after collecting rent and paying rental expenses, so depreciation deductions can be used to turn their profits into tax losses. That’s why rental property is considered such a good tax shelter – because you can report a loss even though you are making a profit.

For example, you collect $12k rent for the year and paid $8k in rental expenses like mortgage interest and property tax. If you took no depreciation deduction, you would have to claim $4k in rental income on top of your regular income… but after a $6k depreciation deduction (typical for property worth $165k), you will claim a $2k loss while still making a $4k profit.

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The Gulf Opportunity Zone Act established a 50% bonus depreciation allowance as a tax incentive to rebuild the economies devastated by hurricanes Katrina and Rita.

To qualify for the bonus depreciation, the property must be listed within the GO Zone, new, acquired after Aug. 27, 2005, and placed in service before Dec. 31, 2008.The 50% bonus depreciation method must be selected before any other depreciation deductions have been made.

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You can maximize your property basis by accounting for closing costs, which will save you more money because you get to deduct more than you already do (assuming you don’t already account for closing costs).

By increasing your depreciable basis, you enable yourself to take larger depreciation deductions, which results in a lower taxable liability (the taxes you owe).

To optimize your property basis, find the Contract Sales Price, which is on Line 101 of your Settlement Statement. You can add items unpaid by the seller (Lines 210-212) but be sure to subtract items paid by the seller in advance (Lines 106-108).

Next you must add Title Charges (Lines 1100-1110), Recording and Transfer Charges (Lines 1200-1205) and Additional Settlement Costs (Lines 1300-1302).

This gives you the maximum depreciable basis for your property. Divide this number by 27.5 (for residential property), and this gives you your yearly depreciation deduction.

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You should deduct all of your loan costs to maximize your tax savings.

Unlike title charges, loan costs do not add value to your property, and therefore must be must be amortized over the life of your loan (and not depreciated with the property basis.)

To find out your yearly amortization deduction, add all the loan costs from your property’s settlement statement (Lines 800-807) and divide it by the loan term (30 years, etc…)

You will report this yearly amortization deduction on IRS Form 4562 for the life of the loan.

If you refinance in a certain year, you will get to deduct all the remaining unamortized points that year, after which you will have a new amortization schedule for your new loan.

You can deduct the remaining points on Schedule E under “other expenses.”

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