Properly managing inherited real property means maximizing your return to build a suitable nest egg for your blossoming marriage. If you decide to rent the newly acquired property, depreciating the property will help offset rental income to minimize taxes owed. Although this is complicated enough with purchased property, inherited properly adds an additional level of difficulty by not having an obvious purchase price to serve as an initial cost basis.
What Is Depreciation?
Depreciation allows you to deduct the inherited property's value over several years, but this depreciation is limited to structures. According to the Internal Revenue Service, land does not wear out or become depleted, so you cannot deduct land value when depreciating the property. Depreciation does not allow you to gain money from the IRS, but it allows you to offset income generated by, or in association with, the property up to the total amount earned.
Inherited Property's Depreciation Eligibility
To be eligible for depreciation, you must own the property, which means the legal transfer of ownership must be completed after the death of the original owner. The property must also be associated with an income-generating activity, such as a rental property or property used in conjunction with your business. According to the IRS, depreciation additionally requires the property to have a "determinable useful life" of more than one year, but this requirement is already met by the nature of real property.
Inherited Property's Cost Basis
The inherited property's cost basis is the amount being depreciated over the useful life of the property. This value is estimated by the fair market value at the time of the decedent's death, minus any estimated land value.
As an example, if comparable properties were sold at that time for $200,000 and $50,000 of that is considered land value, the cost basis is $200,000 minus $50,000, or $150,000. You may also add legal, survey and recording fees to this sum when incurred during the ownership transfer.
Property's Recovery Period
The recovery period is the number of years over which the property is depreciated. This period depends on the property's usage. For residential rental properties, the recovery period is 27.5 years, but for business use of homes or commercial rentals, the recovery period is 39 years.
Calculating Property Depreciation
Dividing the cost basis by the recovery period will calculate the annual depreciation. If the property is only partially used in conjunction with an income-producing activity, you can only deduct the percentage used for business purposes.
In the previous example, if only 25 percent of the $150,000 cost basis property was used as a home office, dividing $150,000 by 39 years calculates the gross depreciation of $3,846. Further multiplying this figure by the 25 percent business usage calculates your total depreciation of $962.
- Internal Revenue Service: Publication 946 – How to Depreciate Property
- Internal Revenue Service: Publication 17 (2018),Your Federal Income Tax
- Internal Revenue Service: Publication 225 (2018), Farmer's Tax Guide
- Internal Revenue Service: Publication 946 (2017), How To Depreciate Property
- Internal Revenue Service: Publication 527 (2018), Residential Rental Property