When exploring the world of residential real estate, one question often arises: "Can I depreciate my rental property that I live in?" The simple answer is no, not in the way you might expect. However, a deeper understanding of the tax laws can reveal that it's not quite as straightforward as it seems.
Primarily, depreciation is a tax deduction that allows rental property owners to recover the cost or value of an asset over time. This is typically calculated based on the asset's useful life, as established by the Internal Revenue Service (IRS). But when you live in the property, the rules change due to the IRS's definition of personal and rental use.
Understanding the IRS's Definition of Personal and Rental Use
The IRS defines personal use as any period during which you live in the dwelling unit, including days when you're away. This includes not only the time you actively reside in the property but also any periods when it's vacant because you're on vacation or away on business.
On the other hand, rental use refers to the time your property is physically rented out to others. This can vary from short-term rentals (like Airbnb) to long-term leases (like a one-year apartment lease). The key distinction is that during these periods, you do not live in the property.
The 14-Day Safe Harbor Rule
While you cannot depreciate the portion of your home used as your personal residence, the IRS does allow for a 14-day safe harbor rule. This means that if you rent out your primary residence for 14 or fewer days per year, you can deduct your rental expenses (including mortgage interest, property taxes, insurance, and depreciation) in full, regardless of the amount of personal use.
However, there are a few caveats. First, you cannot deduct rental income for those 14 days or fewer. Second, you must not provide significant services to your guests, such as maid service or personal greetings. Lastly, while you can still advertise your property on platforms like Airbnb, you cannot deduct the advertising costs.
Evicting Yourself: The One-Year Absence Rule
Another exception to the personal use rule is the one-year absence rule. If you do not live in your home for at least one year, you can claim it as a rental property for the entire time it's vacant. However, this requires formally evicting yourself from the property, which can have legal and practical implications that should be carefully considered.
Moreover, if you return to the property after it has been vacant, you'll need to live there again for a full year before the one-year absence rule applies again. This can create a complex cycle of eviction and re-occupation, making it important to consult with a tax professional before attempting to take advantage of this rule.
Depreciating the Business Portion of Your Rental Property
If you have a business portion of your home, such as a home office, you may be able to depreciate that part. To qualify, the area must be exclusively and regularly used for business purposes. This can include home offices, studios, or workshops used for business activities.
The depreciation of business-use assets is calculated using the IRS's Modified Accelerated Cost Recovery System (MACRS). However, the depreciation period for residential real property (including rental homes) is 27.5 years, significantly longer than the 5- or 7-year periods for most other business-use assets.
Calculating the Business Portion
To determine the portion of your home that qualifies for depreciation, you'll need to calculate the square footage of your business-use area, then divide that by the total square footage of your home. For example, if you have a 2,000-square-foot home with a 200-square-foot home office, 10% (200/2000) of your home is potentially depreciable.
It's important to note that any personal use of the business area reduces the depreciation deduction. However, you're only considered to have personal use if the business area is used for personal purposes more than 14 days during the year or more than 10% of the time it's used for business.
In the world of rental properties, understanding the tax implications is key to making informed decisions. While you cannot depreciate the personal use portion of your home, there are exceptions and nuances that can help you optimize your taxes. Unless you're comfortable navigating these complex rules, it's always a good idea to consult with a tax professional or real estate accountant.