Does the IRS require a specific depreciation method for foreign residential rental property reported on Schedule E?
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Yes, the IRS requires a specific depreciation method for foreign residential rental property reported on Schedule E. Under the Internal Revenue Code, foreign residential rental property must be depreciated using the Alternative Depreciation System (ADS), which employs the straight-line method over a prescribed recovery period.
Legal Framework
1. Requirement to Use ADS for Foreign Property
- IRC § 168(g)(1)(A): This section mandates that any tangible property used predominantly outside the United States must be depreciated under the Alternative Depreciation System (ADS), rather than the General Depreciation System (GDS).
- IRC § 168(g)(2)(A): Under ADS, the straight-line method must be used, and the applicable recovery period is determined by statute or class life.
2. Recovery Periods
- IRC § 168(g)(2)(C): For residential rental property, the ADS recovery period is 30 years for property placed in service after December 31, 2017, and 40 years for property placed in service before January 1, 2018.
- IRC § 168(g)(2)(D): For nonresidential real property, the ADS recovery period is 40 years.
3. Methodology
- Straight-Line Method: Under ADS, depreciation is calculated using the straight-line method, which means the property’s basis (cost plus capital improvements, minus prior depreciation) is divided evenly over the recovery period.
- No Accelerated or Bonus Depreciation: Foreign property is not eligible for accelerated depreciation methods (such as 200% or 150% declining balance) or for bonus depreciation under IRC § 168(k).
4. Application to Schedule E
- Schedule E Reporting: U.S. taxpayers must report foreign rental income and expenses, including depreciation, on Schedule E (Form 1040). The depreciation deduction for foreign residential rental property must be calculated using the straight-line method over the appropriate ADS recovery period.
5. Summary of Requirements
- Depreciation System: Alternative Depreciation System (ADS)
- Method: Straight-line
- Recovery Period: 30 years (for property placed in service after December 31, 2017); 40 years (for property placed in service before January 1, 2018)
- No bonus or accelerated depreciation allowed
- Required for all foreign residential rental property, regardless of taxpayer election
6.Practical Example
If you purchase a foreign residential rental property in 2025, you must depreciate it using the straight-line method over 30 years under ADS. Each year, you deduct 1/30th of the property’s depreciable basis as a depreciation expense on Schedule E.
7. Conclusion
The IRS requires that foreign residential rental property reported on Schedule E be depreciated using the straight-line method under the Alternative Depreciation System (ADS), with a recovery period of 30 years (if placed in service after December 31, 2017) or 40 years (if placed in service before January 1, 2018). This is a mandatory requirement; no other depreciation method is permitted for such property.
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