The 2024 Guide to Calculating Accelerated Depreciation for Single Family Rentals

As a real estate investor, you're always looking for ways to maximize your returns and minimize your tax liability. One powerful tool that can help you achieve both goals is accelerated depreciation.

Accelerated depreciation allows you to front-load your depreciation deductions, taking larger deductions in the early years of ownership and smaller deductions later on. This strategy can provide significant tax savings and boost your cash flow in the short term.

In this article, we'll dive into the specifics of accelerated depreciation for single family rentals. We'll explore how it works, how to calculate it, and whether it's the right choice for your investment portfolio.

What is Accelerated Depreciation for Single Family Rentals?

Accelerated depreciation is a method that allows rental property owners to deduct more of an asset's cost in the early years of ownership. Unlike straight-line depreciation, which spreads the deductions evenly over the property's useful life (27.5 years for residential properties), accelerated depreciation front-loads the deductions.

This means you can claim larger depreciation expenses in the first few years after acquiring a rental property, reducing your taxable income and potentially increasing your cash flow. However, it's important to note that the total amount of depreciation you can claim over the property's life remains the same; accelerated depreciation simply changes the timing of those deductions.

Example of Accelerated Depreciation

Let's say you purchase a single family rental property for $200,000, with $50,000 allocated to land value and $150,000 to the building itself. Under the straight-line method, you would depreciate the building over 27.5 years, claiming $5,454.55 each year ($150,000 / 27.5).

With accelerated depreciation, you might use the double-declining balance method, which allows you to depreciate the property at twice the straight-line rate. In the first year, you would claim a depreciation deduction of $10,909.09 (2 x $5,454.55), nearly double the amount you'd claim under the straight-line method.

• Accelerated depreciation provides larger deductions in the early years: By front-loading your depreciation deductions, you can reduce your taxable income more significantly in the first few years of ownership. This can be particularly beneficial if you anticipate higher rental income during this period.
• The total amount of depreciation remains the same: While accelerated depreciation allows you to claim deductions faster, the total amount you can depreciate over the property's useful life doesn't change. In later years, your depreciation deductions will be smaller than they would be under the straight-line method.
• Accelerated depreciation can improve cash flow: By reducing your taxable income, accelerated depreciation can help you keep more of your rental income in the early years of ownership. This extra cash flow can be reinvested in your property, used to pay down debt, or allocated to other investments.

Calculating Accelerated Depreciation for Single Family Rentals

To calculate accelerated depreciation for your single family rental property, you'll need to follow a few key steps. First, you must determine the cost basis of your property, which includes the purchase price, closing costs, and any improvements made. This will be the total amount you'll depreciate over the property's useful life.

Next, you'll choose an accelerated depreciation method, such as the double-declining balance method or the sum-of-the-years' digits method. Each method has its own formula for calculating the depreciation deduction for each year.

It's important to keep accurate records of your property's cost basis and any improvements made over time. This documentation will be necessary when filing your tax returns and claiming your depreciation deductions.

Determine the Cost Basis

• Purchase price is the starting point: The cost basis begins with the price you paid to acquire the property, including any down payment and mortgage financing.
• Closing costs are added to the basis: Expenses such as title insurance, legal fees, and recording fees can be added to your cost basis, increasing the total amount you can depreciate.
• Improvements increase the basis: Any improvements you make to the property, such as renovations, additions, or major repairs, can also be added to your cost basis. Keep records of these expenses to support your depreciation deductions.

How does bonus depreciation work

Bonus depreciation is a tax incentive that allows you to deduct a significant portion of an asset's cost in the year it's placed in service. For assets acquired and placed in service after September 27, 2017, and before January 1, 2023, you can deduct 100% of the cost in the first year.

Starting in 2023, the bonus depreciation percentage decreases by 20% each year. In 2024, the bonus depreciation rate is 80%. This means that for eligible assets placed in service in 2024, you can deduct 80% of the cost in the first year, with the remaining 20% depreciated under the normal depreciation schedule.

To qualify for bonus depreciation, the asset must have a recovery period of 20 years or less under the Modified Accelerated Cost Recovery System (MACRS). This includes most types of rental property improvements, such as appliances, flooring, and roofing.

Is Accelerated Depreciation Worth It for Single Family Rentals?

Accelerated depreciation can be a powerful tool for single family rental property owners looking to maximize their tax benefits and improve cash flow. By front-loading depreciation deductions, you can reduce your taxable income in the early years of ownership, when rental income is often highest.

This strategy can be particularly advantageous if you plan to hold the property for a shorter period or if you anticipate significant income from other sources during the early years of ownership. The increased cash flow from accelerated depreciation can be reinvested in the property, used to pay down debt, or allocated to other investments.

However, it's important to consider the potential drawbacks of accelerated depreciation before deciding if it's the right choice for your single family rental property.

• Lower depreciation deductions in later years: While accelerated depreciation provides larger deductions upfront, it also means you'll have smaller deductions in later years. This can result in higher taxable income and potentially higher tax liabilities down the road.
• Depreciation recapture upon sale: When you sell a rental property that has been depreciated, you may be subject to depreciation recapture. This means you'll owe taxes on the portion of the sale price that represents the depreciation claimed over the years. Accelerated depreciation can lead to a larger depreciation recapture tax liability when you sell the property.
• Complexity and recordkeeping: Calculating and claiming accelerated depreciation deductions can be more complex than using the straight-line method. You'll need to keep accurate records of your property's cost basis, improvements, and depreciation claimed each year. Working with a tax professional can help ensure compliance and maximize your tax benefits.

Accelerated depreciation can be a powerful tool for maximizing your tax benefits and improving cash flow as a single family rental property owner. By front-loading your depreciation deductions, you can reduce your taxable income in the early years of ownership, freeing up more capital to reinvest in your property or pursue other investment opportunities.

However, before deciding if accelerated depreciation is the right strategy for your rental property, it's essential to weigh the potential drawbacks and consult with a tax professional to ensure it aligns with your overall investment goals. If you're ready to take advantage of the benefits of real estate investing without the hassle of traditional methods, get started with Doorvest today. Our full-service platform simplifies the process of investing in single family rental homes, helping you build long-term wealth and achieve financial security.