What if You Forgot to Depreciate Your Rental Property?

If you forgot to depreciate your rental property, don’t worry! Just follow these easy steps to claiming it after the fact.

What is Depreciation?

Before you proceed with any actions, it’s important to understand what depreciation is. Depreciation represents how much a home’s value has decreased over time. A home can depreciate based on its age, wear and tear, changes in the neighborhood and market conditions. Any residential rental property placed in service after 1986 is depreciated using the Modified Accelerated Cost Recovery System (MACRS), an accounting technique that spreads costs (and depreciation deductions) over 27.5 years, the amount of time the Internal Revenue Service (IRS) considers to be the “useful life” of a rental property.

Technically, you are not required to depreciate your property, but if you plan on selling it, you will need to “recapture” the depreciation for the years you owned it. According to the IRS, “If you were entitled to take depreciation deductions because you used your home for business, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997.” This means that you will end up paying tax on the depreciation recapture whether you claimed it or not.

Should You Depreciate Your Rental Property?

Even though depreciating your rental property isn’t really required, depreciating your property sooner rather than later may actually help you in the long run. This is because the tax due on your recapture gain will be lower than if you never depreciated at all. In other words, decreasing your taxable income today while you are in a higher tax bracket usually has a positive effect on your tax.

How to Depreciate Now

So, if you forgot to depreciate your rental when you first got it, there’s still a way to depreciate it now. This way, you won’t have to wait for the IRS to do it once you decide to sell it in the future. You should claim catch-up depreciation on your rental property to make up for the time you lost. Catch-up depreciation is simply an adjustment made on your tax return. This usually happens when you didn’t claim depreciation in prior years, or you claimed more or less than the “allowable” depreciation. Instead of filing an ammended return, you should correct the tax form from the year you forgot to depreciate. You can do this by filing Form 3115, which is the “Application for Change in Accounting Method.”