When you invest in real estate, you’ll often find yourself at odds with depreciation.

Depreciation represents the value that your property loses over the course of its lifespan — but because nothing is built to last forever, the IRS does offer a bit of support in the form of a depreciation deductible.

If you own a brand-new property that’s in amazing shape, it’s typically going to take a pretty long time until you’re in a position to deduct a loss in value. That’s why many real estate investors use accelerated depreciation.

Accelerated depreciation is a tax strategy in which landlords are able to itemize assets within a property and use each asset’s individual aging process to depreciate the property’s total value. 

In some cases, it can represent a big tax savings for investors. In other cases, it can lead to a bigger tax bill further down the road if your rental property ends up changing hands. 

This guide explains the different types of accelerated depreciation, how to deduct depreciation on your tax return, and what you should bear in mind before using this strategy.

Key Takeaways

• Accelerated depreciation lets investors depreciate things inside a house on an individual basis rather than let the property depreciate as a singular entity.

• The key benefit of accelerated depreciation is that it lets you deduce more costs associated with your property over a shorter period of time.

• The biggest risks you’ll face by accelerating depreciation are depreciation recapture and over-complicating your annual tax return.

What is Accelerated Depreciation?

Accelerated depreciation is a common depreciation method that property owners use to lower their tax liabilities. Accelerated depreciation can be used on a number of asset classes — but it’s particularly common where rental properties are concerned.

In real estate, accelerated depreciation works by letting various elements of a property depreciate their full value over their useful lifespan individually instead of letting the property depreciate as one umbrella entity that includes all the “stuff” inside.

For example, the tiling in a rental property is going to wear out a lot faster than the actual structure of the building. 

That means the tiling you’ve installed can be depreciated quicker — and you can then claim a bigger depreciation deduction on your tax return during the initial period it’s in use.

Other rental property elements you can often accelerate depreciation on include essentials like light fixtures, the stove, furnace, heating system, boiler, windows, security system, and everything in between.

What Are the Different Types of Accelerated Depreciation?

The two most popular types of accelerated depreciation are the Double-Declining Balance Method (DDB) and the Sum of the Years’ Digits (SYD) methods.

When you use DDB, you’re taking the reciprocal of the useful life of an asset and then multiplying it by two. That rate then gets applied to the asset’s book value for the remainder of its expected usefulness.

For example, let’s say you’ve bought an oven you expect to have a useful life of five years. You’d apply a reciprocal value of 1/5 (or 20%). You’d then double that rate to 40%, and apply it to the book value of the oven for depreciation.

Even though the depreciation rate of the oven will stay the same, the value will change as it gets multiplied by an increasingly smaller depreciation base each tax year.

Next, you’ve got the SYD method.

When you use SYD, you’re combining all of the digits in your asset’s expected lifespan and then sequentially depreciating a fraction of that sum each year.

For example, let’s say you’ve installed a garage door you expect to last for five years. You’d take the sum of the digits one through five to get 15. 

That means for your first year of depreciation, you’d write off 5/15 of your depreciable base. The next year you’d take away 4/15, and move down the number line each year until you’re left with just 1/15 of your base left.

Why Would You Want to Accelerate Depreciation on a Rental Property?

Accelerated depreciation on a rental property can be a useful strategy for investors in a number of ways — but the top benefit of accelerated depreciation is that it lets you deduce more costs associated with your property over a shorter time period.

Translation: accelerated depreciation enables you to keep more of your money sooner.

But according to Josh Dotoli, Principal of the Dotoli Group, the benefits of accelerated depreciation extend far beyond the ability to deduct certain parts of your property quicker than others.

“Accelerating depreciation also helps to reduce taxable income, which can give you some tax savings,” he says.

“Additionally, accelerating depreciation can be beneficial for businesses by allowing them to free up more cash flow in the early years after making a purchase, as well as reducing their tax burden when they are at their most profitable. It also helps keep businesses competitive by providing an incentive to reinvest and upgrade their facilities.”

But accelerating depreciation is also a simple way to increase your cash flow — potentially increasing the value of your property along with it. That being said, it’s important to note that accelerated depreciation does have a limit.

“If accelerated depreciation brings the income below zero, the owner of the property may or may not be able to utilize this loss, depending on their status as a real estate professional in the Tax Code,” Greg O'Brien, Co-CEO of Anomaly CPA.

Last year, the maximum depreciation deduction you could claim was $1,160,000.

How Do You Claim an Accelerated Depreciation Deduction on Your Tax Return?

If you own a rental property, the IRS lets you write off depreciation on your annual tax return in the form of a depreciation deduction. According to the IRS, depreciation is “an allowance for the wear and tear, deterioration or obsolescence of the property”.

Any landlord can deduct depreciation on their annual return — but if you want to use accelerated depression, there’s an extra step you’ll need to take first.

The first step is to conduct a cost segregation study.

A cost segregation study is essentially an audit of your property that separately catalogs each and every fixture, element, or structure and their various lifespans. Once you’ve completed a cost segregation study, you’ll be able to accelerate depreciation on all of the property’s assets that have shorter lifetimes than the structure itself.

If you’re planning to use accelerated depreciation on your investment property, you’ll need to chart your deductibles on Form 4562 and file it alongside your annual return.

What Are the Risks of Accelerating Depreciation on a Rental Property?

Like any tax reduction strategy, accelerating depreciation does go hand-in-hand with a couple of risks — and one of the biggest risks is that it could lead you to mess up your tax numbers.

“The primary risk of accelerating depreciation on a rental property is that the value of the asset may be overstated, leading to incorrect tax reporting,” says Josh Dotoli.

“It could also lead to a miscalculation of cash flow for the current year, as more expenses are being claimed than necessary.”

That’s why it’s critical that investors get professional advice and keep crystal-clear financial records when adopting an accelerated depreciation strategy — and it’s also where tools like Trustworthy offer invaluable support.

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Yet in addition to complicating your filing, depreciation also carries another risk insofar as you might simply be kicking a can down the road where your tax bill is concerned.

“Accelerating depreciation can reduce your taxable income and thus lower the amount of taxes you owe. However, when you sell the property, you may have to pay recapture taxes on some of the depreciation deducted in earlier years,” explains Sarah Momsen, Member & CTO at JiT Home Buyers.

“This means that while accelerated depreciation can help reduce current tax liabilities, it can also lead to a larger tax bill in the long run.”

Depreciation recapture can take place in a few different circumstances — and in some cases, it could lead to an IRS audit in which you’re disallowed some of the depreciation deductions you’ve already made.

To help you understand how, let’s take a closer look at depreciation recapture and its risks.

What is Depreciation Recapture and How Does It Work?

Depreciation recapture is the process in which the IRS collects taxes that a property investor has already used to offset taxable income. It generally occurs after you decide to sell a rental property.

“The IRS will determine how much of your gain from selling the property is considered to be taxable income and how much can be excluded via depreciation recapture,” says Josh Dotoli.

“Depreciation recapture is calculated by subtracting the total amount of depreciation taken from the adjusted basis. The adjusted basis is the original cost of purchasing and improving your property, plus any capital improvements made on it, minus any losses incurred due to casualty or theft.”

The difference between these two numbers is then taxed at a rate of 25%. 

Translation: if you’ve taken $20,000 in depreciation on an adjusted basis of $50,000, the taxable gain will be taxed at 25% as a capital gain.

It’s also worth noting that depreciation recapture will also apply if you take a rental property and convert it to personal use. That’s because ordinary homeowners aren’t allowed to claim accelerated depreciation. 

Because of the risk of depreciation recapture — as well as potential filing errors — it’s highly recommended that you seek professional advice before utilizing this strategy.

“My advice to someone considering using an accelerated depreciation technique on their rental property would be to carefully consider the risks and potential tax implications,” says Sarah Momsen.

“It can be beneficial in the right circumstances, but it's important to understand the potential consequences before making a decision.”

Frequently Asked Questions

What is the Best Depreciation Method for Rental Property?

Although accelerated depreciation lowers your tax bill quicker, straight-line depreciation is widely considered the simplest method and generally yields the most favorable tax treatment.

Is Accelerated Depreciation Good or Bad?

Accelerated depreciation can be a great way to maximize deductions and lower tax liabilities on rental properties. But you may end up repaying those savings later through depreciation recapture.

What are the Two Most Common Examples of Accelerated Depreciation Methods?

The two most common methods of accelerated depreciation in real estate are the Double-Declining Balance (DDB) method and the Sum of the Years' Digits (SYD) method.