 Income tax 2021-2022, depreciation of rental property part number four. 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 Taxure 2021 on the IRS, website irs.gov, irs.gov. Income tax formula focused in on line one, income. We would have a subschedule, basically an income statement with income and expenses, expenses basically being deductions to net then what rolls in to line one income of the income tax formula as well as eventually page one of the form 1040. This is the Schedule E, basically that income statement schedule where we have the supplemental income and loss we're focusing in on the rental real estate. So we're continuing on with our discussion now talking about additions or improvements. So add to the basis of your property, the amount and addition or improvement actually costs you, including amount you borrow to make the addition or improvement. So when we have additions to the property, we're going to have the question, is it a repair? Is it something I could expense possibly at this point in time, or is it an improvement? And if it's an improvement, then we're going to have to basically capitalize it if it was an addition or improvement before we put the property in to use, then we're going to have added to the cost of that property. So this includes all direct costs such as material and labor, but doesn't include your own labor. So 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. So it's not like you're going to put architect fee under, you know, professional fees or something like that, although the architect is of course a professional, but he's doing work that's going towards the improvement of the property. Therefore, we're going to have to capitalize it generally as the improvements of the property. We're going to get the benefit of the expense, but not necessarily upfront instead through the depreciation of the property, which is not what we would prefer because we have to do that over a longer period of time and or we get the benefit. When we sell the property, having the increase in the basis, lowering the gain on the sale of the property, gain calculated as the sales price minus the basis. So or if you had, if you had your lot surveyed to put up a fence, the cost of the survey is part of the cost of the fence. So you got to say, Hey, where's the end of my property where I need to put the fence on it? My neighbors arguing with me about it, but I know this is where the fence goes because I had a survey done on it. You can't just expense the survey costs. It's really part of the fence that you say you have to capitalize it. So keep separate accounts for depreciation, additions or improvements made after you place the property in service in your rental activity for information on depreciating additions or improvements. You can see additions or improvements to property later in this chapter under recovery periods under GDS caution. The cost of landscaping improvements is usually treated as an addition to the basis of the land, which isn't depreciable. So now when you add the additions on the question is, normally you add an addition and you're like, that's part of the building because it's part of the thing that's going to be deteriorating over time. But you might have landscaping, which could be part of the addition, but it's really kind of something to have been to do with the land, which, which is something you don't depreciate. So you don't want to allocate it to the land, typically if you don't have to. So you're basically tax planning thought process is how can I get this done so I can allocate it at least to the building side of things so that I can get some benefit from the depreciation because if I allocate it to land, I don't get the benefit until I actually sell the property and the form of an increased basis amount. However, see what rental property can't be depreciated earlier. So assumptions for local improvements, assessments for items which tend to increase the value of property, such as streets, sidewalks, must be added to the basis of the property. So improvements that are increasing the value you have to add to the, to the basis. For example, if your city installs curbing on the street in front of your house and assesses you and your neighbors for its costs, you must add the assessment to the basis of your property. Also add the cost of the legal fees paid to obtain a decrease in an assessment levied against property to pay for local improvements. They can't deduct these items as taxes or depreciate them. However, you can deduct assessments for the purpose of maintaining or repairs or for the purpose of meeting interest charges related to the improvements. Don't add them to your basis in the property. Deducting versus capitalizing costs. So deducting means we get the deduction today. Capitalizing means we have to put it on the books as an asset. That's what it means in this context. Being a kind of a complex term because it can be used in different areas, meaning kind of different things. But here we're capitalizing it, putting something that we bought on the books as an asset, not getting the expense upfront, but having to take it over the useful life. Or in other words, over whatever period the government tells us to with the IRS code. So don't add your cost basis. Don't add to your basis costs you can deduct as current expenses. So if you're able to get an expense for it in the current timeframe, then you're not going to add it to the basis of the property. Because if you were to do so, you would in essence be double dipping. You would be getting benefits from two different places for the same thing. Because although you don't get the expense right away, the deduction right away when you capitalize something, you eventually get it when you sell the item in the form of an increase in basis, decrease in the gain, or in the form of depreciation. So 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, don't include them in your basis. The costs you may 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 Chapter 7 of Publication 537. So 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. So we've got to decrease the basis. Basis going down is usually bad because when the basis goes down, that means when we want to have a higher basis, because when we sell the property, we're going to have to recognize possibly a gain or loss. Let's say a gain and the higher basis will mean a lower gain. Remember gains are good in real life, but they're bad for taxes. So for taxes, we want to have a high basis so that we don't have a gain when we sell the property. We cut into that basis when we start to get a benefit, a tax benefit from it, most clearly or obviously when we expense the depreciation costs. The depreciation cost is a reduction in the basis that we're getting a tax benefit for in the current timeframe, reducing like the book value of the property, reducing the basis and the property. In other words, insurance or other payments you received as a result of casualty or theft, casual loss, not covered by insurance for which you took a deduction amounts you received for granting an easement, residential energy credit. You were allowed before 1986 or after 2005 if you added the cost of the energy item to the basis of your home, exclusion from income of subsidies for energy conservation measures, special depreciation allowance for or section 179 deduction claimed as qualified property. That's like the accelerated depreciation depreciation you deducted or could have deducted on your tax return under the method of depreciation. You chose if you don't 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. So now you got your rental property that was used for your main home before you made it into the rental property. You got the gain you postponed from the sale of your main home before May 7th, 1997, if the replacement home was converted to your rental property district. So that's kind of an older, an older rule that took into place with regards to the selling of the property in the past. So once again, gain you postponed from the sale of your main home before May 7th, 1997. So there's kind of the rules with your rental property and what you can do to not have to recognize the gain. Currently, you have like that exclusion, the exclusion there. When you sell the personal residence, which kind of distorts the whole transaction. Before that it was a bit different in terms of how to get a benefit from your personal residence if you were to sell the personal residence. So in any case, District of Columbia, first time home buyer credit allowed on the purchase of your main home after August 4th, 1997 and before January 1st, 2012, amount of qualified principal residence indebtedness discharged on or after January 1st, 2007. Special depreciation allowance. For 2021, some properties used in connection with residential real property activities may qualify for special depreciation allowance. So these are depreciation. Remember that the tax code uses depreciation a little bit differently than generally accepted accounting principles. They kind of start with generally accepted accounting principles, the concept being an accrual concept where we put something on the books because it's gonna be benefiting multiple time periods into the future and then we allocate the cost over like the useful life. That's where the tax code starts, but then they skew it all out of whack when they start to think about benefiting the economy or something like that. And they start putting these accelerated depreciation laws in place and so on, which of course distorts the whole depreciation process. So you've got these special rules with being able to depreciate more or for example, to accelerate the economy. So this allowance is figured before you figure your regular depreciation deduction. See chapter three of publication 946 for details. Also see 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 chapter three of publication 946 and the instructions for form 4562 line 14, makers depreciation. Most business and investment property placed in service after 1986 is depreciating using makers. This section explains how to determine which makers depreciation system applies to your property. It also discusses other information you need to know before you configure depreciation under makers. This information includes the properties. So makers is like the normal for many business properties is the kind of the depreciation method that you're gonna use. The tax code is more stringent than like generally accepted of counting principles, your property is gonna, they're gonna try to have a system where your property falls into certain categories and then you have the restricted options of determining how you're going to depreciate that property often using this makers depreciation methods which is a kind of form of you can think of it as most of the time like a double decline and you usually can use a double decline you might be able to elect a straight line but most people you usually want the accelerated methods so oftentimes you're looking at a double declining half year convention kind of method which is like the default method you might think of with a makers type of depreciation comparing it to normal generally accepted accounting principle depreciation so it's an accelerated method double declining half year convention meaning you kind of assume unless other conditions are met but in general you assume something was purchased in the middle of the year that's the general idea so that means that this information includes the properties recovery class applicable recovery period convention placed in service date basis for depreciation and depreciation method so we got the depreciation systems we've got the makers MACRS consists of two systems that determine how you depreciate your property the general depreciation system known as the GDS and the alternative depreciation system the ADS you must use GDS unless you are specifically required by law to use ADS or you elect to use ADS excluded property you can't use makers for certain personal properties such as furniture and appliances placed in service in your rental property in 2021 if it had been previously placed in service before 1987 when makers became effective in most cases personal property is excluded from makers 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 isn't excluded if your 2021 deduction under makers using a half year convention is less than the deduction would have been would have under ACRS so for more information see what method can what method can use you can use to depreciate your property so that's in publication 946 so generally makers for the most part is what we're going with usually going from here forward so electing ADS so this is the election that you can make if you choose you can use the ADS method for most property under ADS you use the straight line method of depreciation now most of the time you don't choose that because you don't want to use a straight line method you're trying to use the accelerated method because the accelerated method would mean that you get more depreciation earlier which is usually good for taxes but you can imagine situations where you might not want the accelerated depreciation you might already have a loss for example you might not be getting a benefit so maybe there are situations where you say I'd rather have the straight line and depreciate less in the current time frames and so you can imagine situations where you could elect out of that possibly and use a straight line method so the election of ADS for one item is a class of property generally applied to all property in that class 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 non residential rental property if you choose to use ADS for your residential rental property the election must be made in the first year the property is placed in service so that's a big election for residential rental property because that's appreciated over a long period of time as opposed to like equipment which is like anywhere from three to 10 years or seven years or something like that which isn't quite as long as the rental property and so once you make this election you can never revoke it for property placed in service during 2021 you make the election to use ADS by entering the depreciation on form 4562 part three section C line 20 C property classes under GDS each item of property that can be depreciated under makers is assigned to a property class determined by its class life so they're gonna try to be really restrictive or really identify each piece of property as to its class life and so on so that you're driven to how you're going to depreciate something by the tax code more strictly than possibly you would be under other depreciation rules where you might make internal estimates like under generally accepted accounting principles for example so the property class generally determines the depreciation method recovery period and convention the property classes under GDSR you got the three year property you got the five year property you got the seven year property the 10 year property the 15 year property 20 year property and non residential real property and residential real property these are the classes these are the buckets we're putting stuff into that will help us to calculate our depreciation