 Income tax 2021-2022, depreciation of rental property part number six. Get ready to get refunds to the max, diving into income tax 2021-2022. Most of this information can be found in publication 527 residential rental property tax share 2021 IRS website irs.gov irs.gov. Income tax formula, we're focused on line one income. We would have a sub-schedule, basically an income statement with income and expenses. Expenses basically being deductions to net then what rules into line one income of the income tax formula as well as eventually page one of the form 1040. This is the schedule E in essence that income statement schedule. We're looking at the supplemental income and laws and we're focused on the rental real estate. So we're continuing on here with the residential rental property. You must use the straight line method and a mid month convention for residential rental property. So we've been discussing the idea and the fact that when you're thinking about depreciation, the tax code is going to try to be more stringent more than say generally accepted accounting principles where you might try to make an estimate of the useful life. The tax code is trying to say everything fits into these categories that we have here and then you have to depreciate them according to those categories where does the residential rental property fit in that category. Well, we talked about the number of years that the residential rental property is covered over and now we're focused in on the conventions, those conventions being things like a mid year convention, a mid quarter convention, a mid month convention. These are kind of assumptions that we make to estimate and make the calculations a little bit easier in terms of when something was purchased. So if it was purchased in the middle of the month, a mid month convention or if it was purchased anywhere in a month, a mid month convention would say that it was purchased in the middle of the month. If it was a mid year convention, then whenever it was purchased in the year, we assume it was purchased in the middle of the year. If it was a mid quarter convention, then whenever it was purchased in a particular quarter of a year, it was assumed to be purchased in the middle of the quarter. The rental property, the residential rental property, we're gonna use the mid month convention and you can see why they would want to do that. They would want to be more stringent on the convention as opposed to something like five year property which is smaller in dollar amount where they might use a mid year convention in that case because there's so much money involved in the rental property. So you wanna be a little bit more precise with the mid month convention as opposed to a mid year convention for example. So the first year that you claim the depreciation for residential rental property, you can claim depreciation only for the number of months the property is in use. Use the mid month convention explained under conventions earlier. So we've got the five, seven or 15 year property for property in the five or seven year class use the 200% declining balance. That's the double declining. If you know your accounting, you don't have to know the accounting to do this software helps but the double declining method and the half year convention. So if you wanna kinda have an idea of what is happening here, all depreciation methods kind of are based on the idea of a straight line method taking the cost that we have, the basis that we're calculating, allocating it over the useful life which for the tax code is basically whatever they force us to allocate it over because it's a little bit more stringent and that's the general rule. But you might say, hey, we wanna accelerate some of it depreciate more in the front end which sometimes is a logical or rational thing to do not just a funny tax code thing to do because it's likely that things are gonna deteriorate in value faster earlier than later. So it kind of makes sense to depreciate a little bit more upfront instead of evenly over the useful life. So that's kind of a normal, generally accounting principle thing but for taxes, we like that from the taxpayer side and sometimes the code likes that, the tax code that is, the politicians that is because they're trying to stimulate the economy. So, and that one way to do that is to try to incentivize purchasing stuff by allowing people to depreciate more upfront. So that's the double declining method and then they have that half year convention which is a little different than generally accepted accounting principles where you kinda assume it was purchased in the middle of the year if it falls into that five or seven year class. So however, in limited cases, you must use the mid quarter convention if it applies. So, and that usually happens if people, if they feel that you're taking advantage of the mid year convention because what might you do? You might say, hey, I'm gonna try to purchase everything in December. I'm gonna purchase everything in December 31st and then I'm gonna take six months of depreciation on it and the code's gonna say, well now you're kind of abusing this mid year convention thing. So now we're gonna make you use a mid quarter convention. So for property in the 15 year class, you gotta use the 150 double, double the DB method and a half year convention. So that's going to be similar to the, you know, double declining balance of which that's what I would typically call it and in a generally accepted accounting principles but now you got 150 instead of the 200. So it's not double declining. It's 150 declining, 150 declining. Other than that similar kind of concept, you can also choose to use the 150 DB declining balance method for property in the five or seven year class if you choose to do that. You wouldn't typically choose to do that because you would, you get more benefit if you could take more of it upfront or sooner with what I would call the double declining or the 200% declining method but you can imagine situations where you might wanna taper it back a bit possibly because you have a loss or something that's past the threshold or something like that in a current year. So 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. So you can't just pick and choose, you know, you gotta stick to everything in that year at least with that one method that whatever you choose if you choose something different. You make this election on form four, five, six, two and part three column F enter the 150 DB. Once you make this election you can't change it to another method. So you're stuck with it after that point in time because you gotta be consistent. If you use either the 200% or the 100% declining balance method figure your deduction using the straight line method in the first tax year the straight line method gives you an equal or larger deduction. So in other words, that sounds kind of funny. Like you can figure it like the double like if I was gonna calculate the double declining method I would calculate the double declining method but then it's a half year convention. So you take half of it and now you're back to like the normal straight line for the first year. So you end up, it ends up looking like you're in a straight line method even though you're using a kind of a double or 200% declining method. So they're basically saying just use the straight line method in the first year, which is kind of confusing actually because it leads people to think that that's gonna be what happens in year two but it's not because it's a double declining method with a half year convention that they used a straight line method in the first year for because that's what they told us to do. So you can also choose to use the straight line method with a half year or mid quarter convention for five, seven or 15 year property the choice to use the straight line method for one item in a class or property applies to all property in that class that is placed in service during the tax year of the election. So we could use a straight line we wouldn't typically want to do that for tax purposes because that would be less depreciation upfront. We usually want to depreciate more upfront but you can think of circumstances where it might be useful to do that. It might more closely mirror what you're doing on a book basis as well which could be a reason for people to do it but usually you want accelerated depreciation for the tax code. You elect the straight line method on form four, five, six, two in part three column F enter SL that stands for straight line I suppose they didn't tell me that but I'm guessing stands for straight line. Once you make this election you can't change to another method so you're stuck you're locked in that's what it is, it is what it is makers percentage tables you can use the percentage in table two, two to compute annual depreciation under makers so you could do the calculation calculating the double declining method with the mid year convention and so on or you can use the tables which is kind of cheating but that makes it a little bit easier. The tables show the percentages for the first few years or until the change to the straight line method is made. So it's kind of funny when you got that double declining or accelerated method it's kind of a, it's not a very precise method at the end you kind of have to finagle it to work at the end so you don't over depreciate and whatnot but I won't get into that now. See appendix A of publication nine, four, six for complete tables the percentages in table two, two, A two, two, B and two, two, C make the change from the D, B the declining balance to straight line and the year that straight line will give a larger deduction. If you elect to use the straight line method for five, seven or 15 property or the 150 declining balance method for five, seven, five or seven year property use the tables in appendix A of publication nine, four, six which you could find on the IRS website how to use the percentage tables so how do I use those tables once I find them you might ask, well here we go you must apply the tables rate to your property's unadjusted basis define later 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 a depreciation allowed or allowable or an addition or improvement that is depreciated as a separate item of property so most people use the table because most people are using the tax software and the tax software typically uses the table so if there is an adjustment for any reason other than one or two 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 earlier under figuring your depreciation deducted see figuring the deduction without using the tables in chapter four publication nine four six if you want to take a look at that adjusted basis so now we're talking about that basis is again which we start with thought about is like the cost or the adjusted cost of the property that we're going to be allocating or depreciating meaning we're going to be expensing them over time so this is the same basis you would use to figure gain on a sale so the basis is important because when we sell the property and we figure the gain it's the sales price minus the basis the basis is typically going down as we expense it because we're getting the use of the purchase price when we expense it lowering the basis which is lowering the adjusted you know that you can call it the book value which means when we sell it we're going to have a higher gain as we depreciate the property so see basis and depreciation property earlier but without reducing your original basis by any makers depreciation taken in earlier years however you do reduce your original basis by other amounts claimed on the property including any amortization any section one seventy nine deduction and any special depreciation allowance for more information you can see chapter four of publication nine four six and note here we're talking the unadjusted basis is where we're focused at that point so table two two A two two B and two two C the percentages in these tables take into account the half year and mid quarter conventions use table two two A for five year property table two two B for seven year property and table two two C 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 place the property in service now actually of course in practice we're probably going to be using software to help us out with these calculations but we need to understand them both to explain them to people and to be able to plan in the future to the future as to what will happen as well so here's our tables here's the table for the makers GDS percentage tables makers five year so that the half year convention we've got years one through six we've got the mid quarter conventions first quarter second quarter and so on and this is for the seven year property and the 15 year property and the residential property as well so example one let's do an example let's do that the purchase you purchased a stove and a refrigerator and placed them in service in June your basis in the service six hundred dollars in your basis in the refrigerator is one thousand dollars both are five year property using the half year convention column and table two dash two a the depreciation percentage year one is twenty percent for that year your depreciation deduction is one hundred and twenty which is six hundred times twenty percent or point two for the stove and two hundred which is one thousand times twenty percent or point twenty for the refrigerator for year two the depreciation percent is thirty two percent so that year's depreciation deduction will be one hundred and ninety two which is six hundred times thirty two percent or point three two for the stove and three hundred and twenty which is one thousand times thirty two percent or point three two for the refrigerator example number two assume the same facts as an example one except you buy the refrigerator in October so now it's past the year you're gonna have this mid quarter convention thing that's gonna pop into play here instead of June because the refrigerator was placed in service in the last three months of the tax year and its basis one thousand is more than forty percent of the total basis of all property placed in service during the year one thousand six hundred times forty percent equals six hundred and forty uh... you are required to use the mid quarter convention so now we got a switch to the mid quarter tables convention to figure the depreciation on both the stove and and the refrigerator so because you place the refrigerator in service in October you use the fourth quarter column of table two to a and find the depreciation percent for year one is five percent your depreciation deduction for the refrigerators fifty one thousand times five percent or point oh five so i mean and you could calculate this of course using the double uh... the double declining rate and then a mid quarter convention right but but you but you can use the tables here so these are the tables the rules being applied in table format in general the general concept because you place the stove in service in june you use the second quarter column of table two to a and find the depreciation percent for your one is twenty five percent for that year your depreciation deduction for the stove is one hundred fifty which is six hundred times twenty five percent or times point two five table two to d use the table when you are using the gd s twenty seven point five year option for residential rental property the big one the big guy the property itself find the find the row for the month that you place the property in service use the percentage listed for that month to figure your depreciation deduction because now you got a mid month kind of convention you got to be dealing with the mid month convention is taken into account in the percentages showing in the table continue to use the same row month under the column for the appropriate year example time let's do some examples the purchase uh... you purchased a single family rental house for one hundred and eighty five thousand dollars in place it in service on february eight the sales contract showed that the building cost one hundred sixty thousand and the land cost twenty five thousand so you got a break out that land and building thing so we're not going to be depreciating the land we're depreciating the building because the land doesn't deteriorate in human lifetimes typically therefore building only so your basis for the depreciation is its original cost which is the one hundred sixty thousand this is the first year of service for your residential rental property and you decide to use the gd s which has a recovery period of twenty seven point five years of twenty seven and a half years using table two two d you find that the depreciation percent for property placed in service in february of year one mid-month condition february year one is three point one eight two percent uh... that year's depreciation deduction is five thousand ninety one one hundred sixty thousand times three point one eight two percent or point oh three one eighty two again softwares helpful with these calculation figuring makers depreciation under a d s table two one shows the a d s recovery periods for property use in rental activities see appendix be a publication nine four six for other property if your property isn't listed in appendix be it is considered to have no class life under a d s personal property with no class life is depreciated using a recovery period of twelve years used a mid-month convention for residential rental property and non residential rental property for all other property is the half-year or mid-quarter convention as appropriate you can see publication nine four six for a d s depreciation tables claiming the correct amount of depreciation that's important you should claim the correct amount of depreciation each year should we should we really do that okay claim the right amount if you don't 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 now that's a problem right you don't want to give up the depreciation right you don't want to say I missed it and I'm not going to get I'm just not I'm just going to forego that huge deduction on depreciation so you want to make you know you want to make sure to pick it up so for more so for more information see depreciation under decreases in basis in publication five five one if you deducted an incorrect amount of depreciation for property in any year you may be able to make a correction by filing a form ten forty x that's an amended tax return amended us individual tax return so if you messed it up then you want to amend it there is a statute of limitations so you want to do it make sure you you get back in in there and fit in fix it so I if you aren't allowed to make the correction on an amended return you may be able to change your accounting method to claim the correct amount of depreciation see how how to how do you correct depreciation deductions in publication nine four six for more information so if you're looking at something like while the depreciation was totally messed up I didn't claim the depreciation it's past the statute of limitations I can no longer amend the return what do I do well you get pissed off you pull some hair out you say life isn't fair and then you can try looking at publication nine forty six on the iris website and that might help