Depreciation is such an important tax deduction for Airbnb rental owners. This benefit is not always obvious to first-time investors.
Homeowners can deduct the cost of rental property through yearly deductions. Sound deprecation strategy along with 1031 exchange can be a defining factor in making the most out of your Airbnb rental and maximizing the return on your investments.
What is depreciation?
Depreciation is the process of deducting the cost of a business asset over a long period of time, rather than over the course of one year. In layman’s terms, depreciation represents how much of an asset’s value has been used. So instead of taking one giant deduction when you buy or improve the property, depreciation spreads this deduction across the life (determinable useful life) of the property.
Depreciation and Airbnb Rentals (Vacation Rentals)
According to IRS Publication 527, there are four requirements to determine if you are eligible to take a depreciation deduction:
- 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.
What this means is that over time, you can deduct the cost of purchasing the property and the improvements made. This amount will vary depending on your basis for the property, the recovery period, and the depreciation method used. We highly suggest consulting with your accountant about this.
Please note that land is not depreciable since it never gets “used up”. It does not qualify under rule #3, it does not have a determinable useful life.
Vacation rental property can be depreciated over a period of 27.5 years. This process begins when you place the property in service for generating income.
Advanced strategies
There are more advanced strategies such as cost-segregation studies. We dive deep into the cost segregation study in this post.
The cost-segregations study can be a precious tax planning tool. It is used to separate real property into various categories. This allows taxpayers to depreciate their property over much shorter periods of time than the typical 27.5 years.
Connect With a Cost Segregation Expert
This study allows you to separate your expenses into various categories where, some of which have a much shorter schedule or are even deducted at full costs through bonus depreciation.
This can be particularly useful when you are making significant improvements to your property.
What does IRS say about Short-Term Rentals?
In order for short-term rentals to qualify for the depreciation deduction, the property must be rented for longer than:
- 14 days, or
- 10% of the total days you rent it to others at a fair rental price.
How Does Depreciation Reduce Tax Liability?
You typically report rental income and expenses for each rental property on the Schedule of your annual personal income tax return. Depreciation is one of the expenses you include on Schedule E so depreciation reduces your tax liability for the year.
Example:
Depreciation: $5000
Tax Bracket: 24%
Tax Savings: .24*$5000 = $1200 in tax savings that year.
What is depreciation recapture?
Depreciation recapture is the gain realized by the sale of the depreciable capital property that must be reported as ordinary income on your personal tax return. This means that the depreciation that you claimed on the property, will now be taxed if the sale price of the property exceeds the tax basis or adjusted cost basis.
Depreciation recapture can be deferred with a 1031 exchange. See this post on 1031 exchange and Airbnb Rentals for more on this topic
GetChalet Inc. does not provide tax advice and therefore cannot advise investors on the applicability of tax law. If you are considering depreciation strategies, you should consult with your tax advisor.
