When should depreciation basis rental property be recalculated after significant property improvements?
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Depreciation basis for rental property should be recalculated when significant property improvements are made, because these improvements are capitalized and added to the property's basis. The recalculation is necessary to ensure that the depreciation deduction accurately reflects the increased value of the property due to the improvements. Here’s a detailed explanation of when and how this recalculation occurs, based on the relevant tax law and IRS guidance:
1. What Constitutes a Significant Improvement?
A significant improvement is an expenditure that:- Results in a betterment to the property,- Restores the property, or- Adapts the property to a new or different use.
Examples include adding a new roof, installing a new HVAC system, or constructing an addition. Routine repairs and maintenance do not count as improvements and are not added to basis; they are deductible as current expenses.
2. When to Recalculate Basis
You must recalculate (increase) the depreciable basis of your rental property when the improvement is placed in service—that is, when it is ready and available for its intended use in the rental activity. The improvement is treated as a separate asset for depreciation purposes, and its own recovery period and method are determined as if it were placed in service at the same time as the improvement itself.
Key points:- The original property continues to be depreciated on its original schedule.- The improvement is depreciated separately, starting when it is placed in service.- The cost of the improvement is added to the property’s basis for purposes of calculating gain or loss on sale, but for depreciation, it is tracked as a separate asset.
3. How to Recalculate and Depreciate the Improvement
- Determine the cost of the improvement (including all direct costs and related expenses).
- Add the improvement’s cost to the property’s adjusted basis for purposes of gain/loss calculation.
- Depreciate the improvement as a separate asset using the appropriate MACRS recovery period and method (e.g., 27.5 years for residential rental property, 39 years for nonresidential real property, or a shorter period for personal property like appliances or carpeting).
- The recovery period for the improvement begins on the later of (a) the date the improvement is placed in service, or (b) the date the original property is placed in service.
4. Example
Suppose you own a residential rental property and install a new roof for $20,000 in 2025. The new roof is an improvement:- You add $20,000 to your property’s basis for gain/loss purposes.- For depreciation, you start a new 27.5-year MACRS schedule for the $20,000, beginning in the month the roof is placed in service.- The original building continues to be depreciated on its original schedule.
5. Partial Dispositions
If you remove or dispose of a portion of the property (e.g., demolish an old roof), you may be able to write off the remaining undepreciated basis of the disposed portion, provided you make a partial disposition election.
6. Recordkeeping
Maintain detailed records of:- The date and cost of each improvement,- The date each improvement is placed in service,- The depreciation method and recovery period used for each asset.
In summary: You must recalculate (increase) the depreciable basis of your rental property when a significant improvement is placed in service. The improvement is depreciated separately, starting in the month it is ready for use, using the appropriate MACRS recovery period and method for that type of property. The original property’s depreciation schedule is not changed, but the improvement’s cost is added to the overall basis for gain/loss purposes on sale.
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