Investing in real estate comes with many tax benefits that can help an investor significantly reduce tax liability. The write-offs range from mortgage interest and business expense deductions to depreciation expenses.
Depreciated appliances in a rental property are one expense deduction that is sometimes overlooked. If you have a rental property with appliances that are your property and not the tenant’s, keep reading to learn how you can depreciate these items and reduce your tax liability further.
- Rental property depreciation methods include straight-line, accelerated, and bonus depreciation.
- Residential rental real estate is depreciated over 27.5 years. However, appliances in a rental property can be depreciated over a shorter period of time.
- The Internal Revenue Service (IRS) allows rental property appliances belonging to an investor to be depreciated over 5 years, which increases rental property tax write-off in the first few years of ownership.
- Bonus depreciation allows the cost of appliances to be written off in one year, which may allow an investor to report a net loss for tax purposes.
- A cost segregation study must be completed to identify the cost of appliances included in a rental property purchase, and receipts must be saved to prove the cost of new appliances.
What is depreciation?
Depreciation is the process of allocating a tangible asset’s cost over its useful life to account for its decline in value.
In real estate, depreciation applies to the cost of obtaining the property and any improvements you make to it. So, instead of expensing the cost of the property or its improvements as a lump sum when you incur it, you distribute this cost over the years the asset will be in use.
However, the land the building sits on is not depreciated since land is a nondepletable asset, and its value keeps increasing. But the building and other assets like furniture, fixtures, and equipment are depreciable.
How to depreciate appliances in a rental property
Like other assets, appliances are subject to normal wear and tear, hence the depreciation treatment. Generally, the IRS allows for property depreciation over a useful life of 27.5 years.
But the IRS categorizes appliances as individual assets with different recovery periods from the building. For example, appliances have a useful life of 5 years for the purposes of depreciation.
Appliances that qualify for deduction include:
- Washer and dryer
Now that you know the appliance’s useful life, the next step is to determine its basis. The basis is the cost of acquiring the asset or its purchase cost plus delivery and installation fees.
If you have more than one appliance, the depreciation schedules must be different for easier and more organized tracking of these expenses. These individual amounts are then consolidated on Schedule E (IRS Form 1040) under one line item: depreciation expense.
After determining the value of each appliance, you can then choose the depreciation method. There are 2 possible methods of depreciation deductions: the straight-line method and the accelerated depreciation method.
1. Straight-line depreciation method
The straight-line depreciation method involves reducing the value of an asset at the same rate during its useful life. For example, the IRS allows real estate investors to depreciate residential investment property over 27.5 years.
For example, if a single-family residential rental property was purchased for $110,000, including $5,000 worth of appliances, and excluding the land value because land doesn’t depreciate. The depreciation expense used to reduce pretax net income would be $4,000 per year:
- $110,000 cost basis / 27.5 years = $4,000 annual depreciation expense
This method is relatively simple to understand and use. Once you have calculated the depreciation for the first year, you will use the same amount for the rest of the asset’s useful life unless you dispose of it.
2. Accelerated depreciation method
Unlike the straight-line method, where the depreciation amount is the same throughout, accelerated depreciation allows an investor to expense a specific portion of the asset’s value— such as appliances—in the first few years of ownership.
The following example illustrates how depreciating appliances using accelerated depreciation could decrease an investor’s pretax net income:
By accelerating the depreciation of appliances, the investor in this example reduced pretax net income from $1,000 per year to just $182. Over the next 5 years of ownership, pretax income will be $182, assuming that the cost basis does not increase and net income does not change.
That’s why accelerated depreciation is a preferred method of many real estate investors. For starters, it maximizes depreciation benefits in the early years as appliances tend to lose value faster than other assets. Because of this, an investor can lower their tax liability significantly in the asset’s first years.
Second, accelerated depreciation could lead to higher profit reports in your income statement the longer the rental property is held. Remember that the cost of acquiring the appliance in question will affect your income statement and probably lower profit values. But with time, as you post lower depreciation expenses, the profit values will get a boost.
While there are benefits to using accelerated depreciation, the process can be costly. A cost segregation study must be completed to determine the value of items that qualify for accelerated depreciation.
Bonus depreciation for appliances
Now that you know how to depreciate appliances in rental properties, let’s look at other rental property depreciation you may be able to take advantage of.
One widely used but soon-to-be-phased depreciation is the bonus depreciation method. It was initially introduced in 2002 at 50% of the asset’s cost.
However, in 2017 the Tax Cuts and Jobs Act was passed, increasing the rate to 100% until the end of January 2023. This has allowed real estate investors to deduct 100% of the depreciation expense under this method during the first year of the qualifying asset.
Assets that qualify for bonus depreciation must have a useful life of 20 years or less, such as rental property appliances. If the investor in the example above had chosen to use bonus depreciation, the total first-year depreciation expense would have been $8,818, creating a paper loss of $3,818:
Tips for keeping track of appliance depreciation in rental property
Using the straight-line depreciation method is relatively straightforward, so it’s possible to use a spreadsheet to keep track of the expense. But rental property owners segregating costs to claim accelerated and bonus depreciation may find a spreadsheet simply isn’t up to the task.
A much easier way to keep track of rental property depreciation is by signing up for a free account with Stessa, a Roofstock company.
The real estate balance sheet feature on Stessa automatically tracks depreciation expenses, along with property value and the outstanding mortgage balance, to provide a more accurate idea of owner’s equity.
Income and expenses are automatically tracked and posted to the correct rental property and line item. In addition, the comprehensive online dashboard makes it easy to monitor property performance in real time, helping you optimize returns.
Today, tens of thousands of investors use Stessa to track over 250,000 properties with more than $60 billion in asset value. In addition, the rental property management software can track an unlimited number of real estate portfolios and individual single-family rentals (SFRs), residential multifamily buildings, and short-term vacation rentals.
The Stessa Tax Center is free for members of the Stessa Community. It includes a suite of free tax resources created in partnership with The Real Estate CPA, helpful how-to articles detailing tax preparation best practices, and videos to help you get the most from your free Stessa software.
While purchasing appliances for a rental property may be costly, you may be able to increase the monthly rent as well. To make the most of your investment, it’s crucial to understand tax deductions that apply to the rental property to help lower your taxable income as much as possible come April. Investors may want to consult a tax advisor.
One of the rental property tax benefits sometimes overlooked by investors is appliance depreciation. Appliances like fridges, stoves, and dishwashers in your rental property are assets on their own and qualify for depreciation. While you could depreciate these over 27.5 years, accelerated depreciation and bonus depreciation are 2 methods for recovering your costs more quickly.