What is Depreciation?
When you purchase property for business purposes, such as buildings, equipment, machinery, vehicles, and furniture, the IRS does not consider these purchases as deductible expenses. Instead, because of the nature of the property, it is considered an asset that is subject to depreciation. This means that the property is expected to wear out and eventually become obsolete over time, and that the owner therefore suffers a loss.
What Property Qualifies for Depreciation?
To qualify as a depreciable asset, it must meet the following criteria: (1) you must own the property; (2) the property must be used for business or for producing income; (3) the property must have a “determinable useful life”; and (4) the property must last for more than one year.
What is Commercial Real Estate?
Commercial real estate is property that is either: (1) non-residential property purchased and sold for capital gains; or (2) non-residential property rented out to generate income. This may include office buildings, shopping malls, warehouses, factories, retail space, or industrial buildings.
How is Depreciation Calculated?
Commercial real estate falls under IRS tax code Section 1250, which prescribes a “recovery” period of 39 years. Notably, this does not include the land that the property sits on. So when calculating depreciation, it is necessary to take the original value of the property and subtract the value of the land.
For example, if you purchase a warehouse complex for $1.5 million and the value of the land is $300,000, then the depreciable basis of the property is $1.2 million. Using a “straight-line” depreciation method for commercial real estate, that $1.2 million is divided by 39, resulting in an allowable annual depreciation of $30,769.23 over 39 years.
Of course, this is a simplification of a potentially complex calculation and does not account for other depreciation possibilities. These include cost segregation, which essentially breaks down a commercial property into various elements, some of which can be depreciated over a much quicker period. Further, leasehold improvements—or improvements made to a building after a tenant leaves—can also qualify an owner for a 15 year accelerated depreciation of the improvements. The key is to speak with an attorney to find your best option.
An Attorney Can Help You
Commercial real estate presents a fantastic opportunity for income or capital gains; however it is critical to properly depreciate this asset when preparing your business’ tax return. If you need some guidance and want to get it right, contact The Law Offices of Robert S. Thomas. I will take the time to thoroughly present your options so that you can make an intelligent, informed decision. I have been a tax attorney for over twenty years and have a Master of Law Degree (LLM) in Taxation, and a license to practice in the United States Tax Court. Contact The Law Offices of Robert S. Thomas at 847-392-5893 for a consultation or visit our website today.