IRS Tax Returns Publication 527 Residential Rental Property

Contents
Reminders ................... 1
Introduction .................. 2
Chapter 1. Rental Income and
Expenses (If No Personal Use
of Dwelling) ............... 2
Rental Income .............. 2
Rental Expenses .............3
Chapter 2. Depreciation of Rental
Property
................. 5
The Basics ................ 5
Special Depreciation Allowance ....8
MACRS Depreciation .......... 8
Claiming the Correct Amount of
Depreciation
............ 12
Chapter 3. Reporting Rental
Income, Expenses, and
Losses
................. 12
Which Forms To Use ......... 12
Limits on Rental Losses ........ 13
At-Risk Rules ........... 13
Passive Activity Limits ...... 13
Casualties and Thefts ......... 14
Example ................. 14
Chapter 4. Special Situations ...... 15
Condominiums ............. 15
Cooperatives .............. 15
Property Changed to Rental
Use
................. 15
Renting Part of Property ........ 16
Not Rented for Profit .......... 16
Example—Property Changed to
Rental Use
............. 17
Chapter 5. Personal Use of
Dwelling Unit (Including
Vacation Home)
............ 17
Dividing Expenses ........... 17
Dwelling Unit Used as a Home .... 18
Reporting Income and
Deductions
............. 19
Worksheet 5-1. Worksheet for
Figuring Rental Deductions
for a Dwelling Unit Used as a
Home
................ 20
Chapter 6. How To Get Tax Help .... 21
Index ..................... 23
Future Developments
For the latest information about developments
related to Pub. 527, such as legislation enacted
after it was published, go to IRS.gov/pub527.
Reminders
Net Investment Income Tax (NIIT). You may
be subject to the Net Investment Income Tax
(NIIT). NIIT is a 3.8% tax on the lesser of net in-
vestment income or the excess of modified
Department
of the
Treasury
Internal
Revenue
Service
Publication 527
Cat. No. 15052W
Residential
Rental
Property
(Including Rental of
Vacation Homes)
For use in preparing
2016 Returns
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Nov 29, 2016
adjusted gross income (MAGI) over the thresh-
old amount. Net investment income may in-
clude rental income and other income from pas-
sive activities. Use Form 8960, Net Investment
Income Tax, to figure this tax. For more infor-
mation on NIIT, go to IRS.gov and enter “Net In-
vestment Income Tax” in the search box.
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Introduction
Do you own a second house that you rent out
all the time? Do you own a vacation home that
you rent out when you or your family isn't using
it?
These are two common types of residential
rental activities discussed in this publication. In
most cases, all rental income must be reported
on your tax return, but there are differences in
the expenses you are allowed to deduct and in
the way the rental activity is reported on your re-
turn.
Chapter 1 discusses rental-for-profit activity
in which there is no personal use of the prop-
erty. It examines some common types of rental
income and when each is reported, as well as
some common types of expenses and which
are deductible.
Chapter 2 discusses depreciation as it ap-
plies to your rental real estate activity—what
property can be depreciated and how much it
can be depreciated.
Chapter 3 covers the reporting of your rental
income and deductions, including casualties
and thefts, limitations on losses, and claiming
the correct amount of depreciation.
Chapter 4 discusses special rental situa-
tions. These include condominiums, coopera-
tives, property changed to rental use, renting
only part of your property, and a not-for-profit
rental activity.
Chapter 5 discusses the rules for rental in-
come and expenses when there is also per-
sonal use of the dwelling unit, such as a vaca-
tion home.
Finally, chapter 6 explains how to get tax
help from the IRS.
Sale or exchange of rental property. For in-
formation on how to figure and report any gain
or loss from the sale, exchange or other dispo-
sition of your rental property, see Pub. 544,
Sales and Other Dispositions of Assets.
Sale of main home used as rental prop
erty. For information on how to figure and re-
port any gain or loss from the sale or other dis-
position of your main home that you also used
as rental property, see Pub. 523, Selling Your
Home.
Taxfree exchange of rental property oc
casionally used for personal purposes. If
you meet certain qualifying use standards, you
may qualify for a tax-free exchange (a like-kind
or section 1031 exchange) of one piece of
rental property you own for a similar piece of
rental property, even if you have used the rental
property for personal purposes.
For information on the qualifying use stand-
ards, see Rev. Proc. 2008–16, 2008 I.R.B. 547,
at IRS.gov/irb/2008-10_IRB/ar12.html. For
more information on like-kind exchanges, see
chapter 1 of Pub. 544.
Comments and suggestions. We welcome
your comments about this publication and your
suggestions for future editions.
You can send us comments from IRS.gov/
forms. Click on “More Information” and then on
“Give us feedback.”
Or you can write to:
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We respond to many letters by telephone.
Therefore, it would be helpful if you would in-
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the area code, in your correspondence.
Although we cannot respond individually to
each comment received, we do appreciate your
feedback and will consider your comments as
we revise our tax products.
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IRS.gov/forms to download forms and publica-
tions. Otherwise, you can go to IRS.gov/
orderforms to order current and prior-year forms
and instructions. Your order should arrive within
10 business days.
Tax questions. If you have a tax question
not answered by this publication, check
IRS.gov and How To Get Tax Help at the end of
this publication.
Useful Items
You may want to see:
Publication
Travel, Entertainment, Gift, and Car
Expenses
Selling Your Home
Depreciating Property Placed in
Service Before 1987
Business Expenses
Sales and Other Dispositions of
Assets
Casualties, Disasters, and Thefts
Basis of Assets
Passive Activity and At-Risk Rules
How To Depreciate Property
Form (and Instructions)
Depreciation and Amortization
Election To Postpone Determination
as To Whether the Presumption
Applies That an Activity Is Engaged
in for Profit
Passive Activity Loss Limitations
463
523
534
535
544
547
551
925
946
4562
5213
8582
Supplemental
Income and Loss
1.
Rental Income
and Expenses (If
No Personal Use
of Dwelling)
This chapter discusses the various types of
rental income and expenses for a residential
rental activity with no personal use of the dwell-
ing. Generally, each year you will report all in-
come and deduct all out-of-pocket expenses in
full. The deduction to recover the cost of your
rental property—depreciation—is taken over a
prescribed number of years, and is discussed in
chapter 2, Depreciation of Rental Property.
If your rental income is from property
you also use personally or rent to
someone at less than a fair rental price,
first read chapter 5, Personal Use of Dwelling
Unit (Including Vacation Home).
Rental Income
In most cases, you must include in your gross
income all amounts you receive as rent. Rental
income is any payment you receive for the use
or occupation of property. It is not limited to
amounts you receive as normal rental pay-
ments.
When To Report
When you report rental income on your tax re-
turn generally depends on whether you are a
cash or an accrual basis taxpayer. Most individ-
ual taxpayers use the cash method.
Cash method. You are a cash basis taxpayer
if you report income on your return in the year
you actually or constructively receive it, regard-
less of when it was earned. You constructively
receive income when it is made available to
you, for example, by being credited to your
bank account.
Accrual method. If you are an accrual basis
taxpayer, you generally report income when
you earn it, rather than when you receive it. You
generally deduct your expenses when you incur
them, rather than when you pay them.
More information. See Pub. 538, Accounting
Periods and Methods, for more information
about when you constructively receive income
and accrual methods of accounting.
Schedule E (Form 1040)
CAUTION
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Page 2 Chapter 1 Rental Income and Expenses (If No Personal Use of Dwelling)
Types of Income
The following are common types of rental in-
come.
Advance rent. Advance rent is any amount
you receive before the period that it covers. In-
clude advance rent in your rental income in the
year you receive it regardless of the period cov-
ered or the method of accounting you use.
Example. On March 18, 2016, you signed
a 10-year lease to rent your property. During
2016, you received $9,600 for the first year's
rent and $9,600 as rent for the last year of the
lease. You must include $19,200 in your rental
income in 2016.
Canceling a lease. If your tenant pays you to
cancel a lease, the amount you receive is rent.
Include the payment in your rental income in the
year you receive it regardless of your method of
accounting.
Expenses paid by tenant. If your tenant pays
any of your expenses, those payments are
rental income. Because you must include this
amount in income, you can also deduct the ex-
penses if they are deductible rental expenses.
For more information, see Rental Expenses,
later.
Example 1. Your tenant pays the water and
sewage bill for your rental property and deducts
the amount from the normal rent payment. Un-
der the terms of the lease, your tenant does not
have to pay this bill. Include the utility bill paid
by the tenant and any amount received as a
rent payment in your rental income. You can de-
duct the utility payment made by your tenant as
a rental expense.
Example 2. While you are out of town, the
furnace in your rental property stops working.
Your tenant pays for the necessary repairs and
deducts the repair bill from the rent payment. In-
clude the repair bill paid by the tenant and any
amount received as a rent payment in your
rental income. You can deduct the repair pay-
ment made by your tenant as a rental expense.
Property or services. If you receive property
or services as rent, instead of money, include
the fair market value of the property or services
in your rental income.
If the services are provided at an agreed
upon or specified price, that price is the fair
market value unless there is evidence to the
contrary.
Example. Your tenant is a house painter.
He offers to paint your rental property instead of
paying 2 months rent. You accept his offer.
Include in your rental income the amount the
tenant would have paid for 2 months rent. You
can deduct that same amount as a rental ex-
pense for painting your property.
Security deposits. Do not include a security
deposit in your income when you receive it if
you plan to return it to your tenant at the end of
the lease. But if you keep part or all of the se-
curity deposit during any year because your
tenant does not live up to the terms of the lease,
include the amount you keep in your income in
that year.
If an amount called a security deposit is to
be used as a final payment of rent, it is advance
rent. Include it in your income when you receive
it.
Other Sources of Rental Income
Lease with option to buy. If the rental agree-
ment gives your tenant the right to buy your
rental property, the payments you receive under
the agreement are generally rental income. If
your tenant exercises the right to buy the prop-
erty, the payments you receive for the period af-
ter the date of sale are considered part of the
selling price.
Part interest. If you own a part interest in
rental property, you must report your part of the
rental income from the property.
Rental of property also used as your home.
If you rent property that you also use as your
home and you rent it less than 15 days during
the tax year, do not include the rent you receive
in your income and do not deduct rental expen-
ses. However, you can deduct on Schedule A
(Form 1040), Itemized Deductions, the interest,
taxes, and casualty and theft losses that are al-
lowed for nonrental property. See chapter 5,
Personal Use of Dwelling Unit (Including Vaca-
tion Home).
Rental Expenses
In most cases, the expenses of renting your
property, such as maintenance, insurance,
taxes, and interest, can be deducted from your
rental income.
Personal use of rental property. If you
sometimes use your rental property for personal
purposes, you must divide your expenses be-
tween rental and personal use. Also, your rental
expense deductions may be limited. See chap-
ter 5, Personal Use of Dwelling Unit (Including
Vacation Home).
Part interest. If you own a part interest in
rental property, you can deduct expenses you
paid according to your percentage of owner-
ship.
Example. Roger owns a one-half undivided
interest in a rental house. Last year he paid
$968 for necessary repairs on the property.
Roger can deduct $484 (50% × $968) as a
rental expense. He is entitled to reimbursement
for the remaining half from the co-owner.
When To Deduct
You generally deduct your rental expenses in
the year you pay them.
If you use the accrual method, see Pub. 538
for more information.
Types of Expenses
Listed below are the most common rental ex-
penses.
Advertising.
Auto and travel expenses.
Cleaning and maintenance.
Commissions.
Depreciation.
Insurance.
Interest (other).
Legal and other professional fees.
Local transportation expenses.
Management fees.
Mortgage interest paid to banks, etc.
Points.
Rental payments.
Repairs.
Taxes.
Utilities.
Some of these expenses, as well as other less
common ones, are discussed below.
Depreciation. Depreciation is a capital ex-
pense. It is the mechanism for recovering your
cost in an income producing property and must
be taken over the expected life of the property.
You can begin to depreciate rental property
when it is ready and available for rent. See
Placed in Service under When Does Deprecia-
tion Begin and End in chapter 2.
Insurance premiums paid in advance. If you
pay an insurance premium for more than one
year in advance, you cannot deduct the total
premium in the year you pay it. For each year of
coverage, you can deduct only the part of the
premium payment that applies to that year. See
chapter 6 of Pub. 535 for information on deduc-
tible premiums.
Interest expense. You can deduct mortgage
interest you pay on your rental property. When
you refinance a rental property for more than
the previous outstanding balance, the portion of
the interest allocable to loan proceeds not rela-
ted to rental use generally cannot be deducted
as a rental expense. Chapter 4 of Pub. 535 ex-
plains mortgage interest in detail.
Expenses paid to obtain a mortgage.
Certain expenses you pay to obtain a mortgage
on your rental property cannot be deducted as
interest. These expenses, which include mort-
gage commissions, abstract fees, and record-
ing fees, are capital expenses that are part of
your basis in the property.
Form 1098, Mortgage Interest State
ment. If you paid $600 or more of mortgage in-
terest on your rental property to any one per-
son, you should receive a Form 1098 or similar
statement showing the interest you paid for the
year. If you and at least one other person (other
than your spouse if you file a joint return) were
liable for, and paid interest on, the mortgage,
and the other person received the Form 1098,
report your share of the interest on Schedule E
(Form 1040), line 13. Attach a statement to your
return showing the name and address of the
other person. On the dotted line next to line 13,
enter “See attached.”
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Chapter 1 Rental Income and Expenses (If No Personal Use of Dwelling) Page 3
Legal and other professional fees. You can
deduct, as a rental expense, legal and other
professional expenses such as tax return prep-
aration fees you paid to prepare Schedule E,
Part I. For example, on your 2016 Schedule E
you can deduct fees paid in 2016 to prepare
Part I of your 2015 Schedule E. You can also
deduct, as a rental expense, any expense
(other than federal taxes and penalties) you
paid to resolve a tax underpayment related to
your rental activities.
Local benefit taxes. In most cases, you can-
not deduct charges for local benefits that in-
crease the value of your property, such as
charges for putting in streets, sidewalks, or wa-
ter and sewer systems. These charges are non-
depreciable capital expenditures and must be
added to the basis of your property. However,
you can deduct local benefit taxes that are for
maintaining, repairing, or paying interest
charges for the benefits.
Local transportation expenses. You may be
able to deduct your ordinary and necessary lo-
cal transportation expenses if you incur them to
collect rental income or to manage, conserve,
or maintain your rental property. However,
transportation expenses incurred to travel be-
tween your home and a rental property gener-
ally constitute nondeductible commuting costs
unless you use your home as your principal
place of business. See Pub. 587, Business Use
of Your Home, for information on determining if
your home office qualifies as a principal place of
business.
Generally, if you use your personal car,
pickup truck, or light van for rental activities, you
can deduct the expenses using one of two
methods: actual expenses or the standard mile-
age rate. For 2016, the standard mileage rate
for business use is 54 cents per mile. For more
information, see chapter 4 of Pub. 463.
To deduct car expenses under either
method, you must keep records that
follow the rules in chapter 5 of Pub.
463. In addition, you must complete Form 4562,
Part V, and attach it to your tax return.
Pre-rental expenses. You can deduct your or-
dinary and necessary expenses for managing,
conserving, or maintaining rental property from
the time you make it available for rent.
Rental of equipment. You can deduct the rent
you pay for equipment that you use for rental
purposes. However, in some cases, lease con-
tracts are actually purchase contracts. If so, you
cannot deduct these payments. You can re-
cover the cost of purchased equipment through
depreciation.
Rental of property. You can deduct the rent
you pay for property that you use for rental pur-
poses. If you buy a leasehold for rental purpo-
ses, you can deduct an equal part of the cost
each year over the term of the lease.
Travel expenses. You can deduct the ordi-
nary and necessary expenses of traveling away
from home if the primary purpose of the trip is to
collect rental income or to manage, conserve,
or maintain your rental property. You must prop-
RECORDS
erly allocate your expenses between rental and
nonrental activities. You cannot deduct the cost
of traveling away from home if the primary pur-
pose of the trip is to improve the property. The
cost of improvements is recovered by taking
depreciation. For information on travel expen-
ses, see chapter 1 of Pub. 463.
To deduct travel expenses, you must
keep records that follow the rules in
chapter 5 of Pub. 463.
Uncollected rent. If you are a cash basis tax-
payer, do not deduct uncollected rent. Because
you have not included it in your income, it is not
deductible.
If you use an accrual method, report income
when you earn it. If you are unable to collect the
rent, you may be able to deduct it as a business
bad debt. See chapter 10 of Pub. 535 for more
information about business bad debts.
Vacant rental property. If you hold property
for rental purposes, you may be able to deduct
your ordinary and necessary expenses (includ-
ing depreciation) for managing, conserving, or
maintaining the property while the property is
vacant. However, you cannot deduct any loss of
rental income for the period the property is va-
cant.
Vacant while listed for sale. If you sell
property you held for rental purposes, you can
deduct the ordinary and necessary expenses
for managing, conserving, or maintaining the
property until it is sold. If the property is not held
out and available for rent while listed for sale,
the expenses are not deductible rental expen-
ses.
Points
The term “points” is often used to describe
some of the charges paid, or treated as paid, by
a borrower to take out a loan or a mortgage.
These charges are also called loan origination
fees, maximum loan charges, or premium
charges. Any of these charges (points) that are
solely for the use of money are interest. Be-
cause points are prepaid interest, you generally
cannot deduct the full amount in the year paid,
but must deduct the interest over the term of the
loan.
The method used to figure the amount of
points you can deduct each year follows the
original issue discount (OID) rules. In this case,
points are equivalent to OID, which is the differ-
ence between:
The amount borrowed (redemption price at
maturity, or principal), and
The proceeds (issue price).
The first step is to determine whether your
total OID (which you may have on bonds or
other investments in addition to the mortgage
loan), including the OID resulting from the
points, is insignificant or de minimis. If the OID
is not de minimis, you must use the con-
stant-yield method to figure how much you can
deduct.
De minimis OID. The OID is de minimis if it is
less than one-fourth of 1% (0.0025) of the sta-
RECORDS
ted redemption price at maturity (principal
amount of the loan) multiplied by the number of
full years from the date of original issue to ma-
turity (term of the loan).
If the OID is de minimis, you can choose one
of the following ways to figure the amount of
points you can deduct each year.
On a constant-yield basis over the term of
the loan.
On a straight line basis over the term of the
loan.
In proportion to stated interest payments.
In its entirety at maturity of the loan.
You make this choice by deducting the OID
(points) in a manner consistent with the method
chosen on your timely filed tax return for the tax
year in which the loan is issued.
Example. Carol took out a $100,000 mort-
gage loan on January 1, 2016, to buy a house
she will use as a rental during 2016. The loan is
to be repaid over 30 years. During 2016, Carol
paid $10,000 of mortgage interest (stated inter-
est) to the lender. When the loan was made,
she paid $1,500 in points to the lender. The
points reduced the principal amount of the loan
from $100,000 to $98,500, resulting in $1,500
of OID. Carol determines that the points (OID)
she paid are de minimis based on the following
computation.
Redemption price at maturity (principal
amount of the loan)
............... $100,000
Multiplied by: The term of the
loan in complete years ............ × 30
Multiplied by ..................... × 0.0025
De minimis amount ............
$  7,500
The points (OID) she paid ($1,500) are less
than the de minimis amount ($7,500). There-
fore, Carol has de minimis OID and she can
choose one of the four ways discussed earlier
to figure the amount she can deduct each year.
Under the straight line method, she can deduct
$50 each year for 30 years.
Constant-yield method. If the OID is not de
minimis, you must use the constant-yield
method to figure how much you can deduct
each year.
You figure your deduction for the first year in
the following manner.
1. Determine the issue price of the loan. If
you paid points on the loan, the issue price
generally is the difference between the
principal and the points.
2. Multiply the result in (1) by the yield to ma-
turity (defined later).
3. Subtract any qualified stated interest pay-
ments (defined later) from the result in (2).
This is the OID you can deduct in the first
year.
Yield to maturity (YTM). This rate is gen-
erally shown in the literature you receive from
your lender. If you do not have this information,
consult your lender or tax advisor. In general,
the YTM is the discount rate that, when used in
computing the present value of all principal and
interest payments, produces an amount equal
to the principal amount of the loan.
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Page 4 Chapter 1 Rental Income and Expenses (If No Personal Use of Dwelling)
Qualified stated interest (QSI). In gen-
eral, this is the stated interest that is uncondi-
tionally payable in cash or property (other than
another loan of the issuer) at least annually over
the term of the loan at a fixed rate.
Example—Year 1. The facts are the same
as in the previous example. The yield to matur-
ity on Carol's loan is 10.2467%, compounded
annually.
She figured the amount of points (OID) she
could deduct in 2016 as follows.
Principal amount of the loan .......... $100,000
Minus: Points (OID) ................ – 1,500
Issue price of the loan .............. $ 98,500
Multiplied by: YTM ................ × 0.102467
Total .......................... 10,093
Minus: QSI ...................... –10,000
Points (OID) deductible in 2016 ....
$     93
To figure your deduction in any subsequent
year, you start with the adjusted issue price. To
get the adjusted issue price, add to the issue
price figured in Year 1 any OID previously de-
ducted. Then follow steps (2) and (3), earlier.
Example—Year 2. Carol figured the de-
duction for 2017 as follows.
Issue price
...................... $98,500
Plus: Points (OID) deducted
in 2016 .......................
+ 93
Adjusted issue price ............... $98,593
Multiplied by: YTM ................ × 0.102467
Total .......................... 10,103
Minus: QSI ...................... –10,000
Points (OID) deductible in 2017 ....
$ 103
Loan or mortgage ends. If your loan or mort-
gage ends, you may be able to deduct any re-
maining points (OID) in the tax year in which the
loan or mortgage ends. A loan or mortgage may
end due to a refinancing, prepayment, foreclo-
sure, or similar event. However, if the refinanc-
ing is with the same lender, the remaining
points (OID) generally are not deductible in the
year in which the refinancing occurs, but may
be deductible over the term of the new mort-
gage or loan.
Points when loan refinance is more than
the previous outstanding balance. When
you refinance a rental property for more than
the previous outstanding balance, the portion of
the points allocable to loan proceeds
not rela-
ted to rental use generally cannot be deducted
as a rental expense.
Example. Charles refinanced a loan with a
balance of $100,000. The amount of the new
loan was $120,000. Charles used the additional
$20,000 to purchase a car. The points allocable
to the $20,000 would be treated as nondeducti-
ble personal interest.
Repairs and Improvements
Generally, an expense for repairing or maintain-
ing your rental property may be deducted if you
are not required to capitalize the expense.
Improvements. You must capitalize any ex-
pense you pay to improve your rental property.
An expense is for an improvement if it results in
a betterment to your property, restores your
property, or adapts your property to a new or
different use.
Table 1-1 shows examples of
many improvements.
Betterments. Expenses that may result in
a betterment to your property include expenses
for fixing a pre-existing defect or condition, en-
larging or expanding your property, or increas-
ing the capacity, strength, or quality of your
property.
Restoration. Expenses that may be for re-
storation include expenses for replacing a sub-
stantial structural part of your property, repairing
damage to your property after you properly ad-
justed the basis of your property as a result of a
casualty loss, or rebuilding your property to a
like-new condition.
Adaptation. Expenses that may be for
adaptation include expenses for altering your
property to a use that is not consistent with the
intended ordinary use of your property when
you began renting the property.
Separate the costs of repairs and im-
provements, and keep accurate re-
cords. You will need to know the cost
of improvements when you sell or depreciate
your property.
The expenses you capitalize for improving
your property can generally be depreciated as if
the improvement were separate property.
2.
Depreciation of
Rental Property
You recover the cost of income-producing prop-
erty through yearly tax deductions. You do this
RECORDS
by depreciating the property; that is, by deduct-
ing some of the cost each year on your tax re-
turn.
Three factors determine how much depreciation
you can deduct each year: (1) your basis in the
property, (2) the recovery period for the prop-
erty, and (3) the depreciation method used. You
cannot simply deduct your mortgage or princi-
pal payments, or the cost of furniture, fixtures,
and equipment, as an expense.
You can deduct depreciation only on the part of
your property used for rental purposes. Depre-
ciation reduces your basis for figuring gain or
loss on a later sale or exchange.
You may have to use Form 4562 to figure and
report your depreciation. See Which Forms To
Use in chapter 3. Also see Pub. 946.
Section 179 deduction. The section 179 de-
duction is a means of recovering part or all of
the cost of certain qualifying property in the year
you place the property in service. This deduc-
tion is not allowed for property used in connec-
tion with residential rental property. See chap-
ter 2 of Pub. 946.
Alternative minimum tax (AMT). If you use
accelerated depreciation, you may be subject to
the AMT. Accelerated depreciation allows you
to deduct more depreciation earlier in the recov-
ery period than you could deduct using a
straight line method (same deduction each
year).
The prescribed depreciation methods for
rental real estate are not accelerated, so the de-
preciation deduction is not adjusted for the
AMT. However, accelerated methods are gen-
erally used for other property connected with
rental activities (for example, appliances and
wall-to-wall carpeting).
To find out if you are subject to the AMT,
see the Instructions for Form 6251.
The Basics
The following section discusses the information
you will need to have about the rental property
and the decisions to be made before figuring
your depreciation deduction.
Examples of Improvements
Additions
Bedroom
Bathroom
Deck
Garage
Porch
Patio
Lawn & Grounds
Landscaping
Driveway
Walkway
Fence
Retaining wall
Sprinkler system
Swimming pool
Miscellaneous
Storm windows, doors
New roof
Central vacuum
Wiring upgrades
Satellite dish
Security system
Heating & Air Conditioning
Heating system
Central air conditioning
Furnace
Duct work
Central humidifier
Filtration system
Plumbing
Septic system
Water heater
Soft water system
Filtration system
Interior Improvements
Built-in appliances
Kitchen modernization
Flooring
Wall-to-wall carpeting
Insulation
Attic
Walls, floor
Pipes, duct work
Table 1-1.
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Chapter 2 Depreciation of Rental Property Page 5
What Rental Property
Can Be Depreciated?
You can depreciate your property if it meets all
the following requirements.
You own the property.
You use the property in your business or
income-producing activity (such as rental
property).
The property has a determinable useful
life.
The property is expected to last more than
one year.
Property you own. To claim depreciation, you
usually must be the owner of the property. You
are considered to be the owner of property
even if it is subject to a debt.
Rented property. Generally, if you pay rent
for property, you cannot depreciate that prop-
erty. Usually, only the owner can depreciate it.
However, if you make permanent improvements
to leased property, you may be able to depreci-
ate the improvements. See Additions or im-
provements to property, later in this chapter un-
der Recovery Periods Under GDS.
Cooperative apartments. If you are a ten-
ant-stockholder in a cooperative housing corpo-
ration and rent your cooperative apartment to
others, you can depreciate your stock in the
corporation. See chapter 4, Special Situations.
Property having a determinable useful life.
To be depreciable, your property must have a
determinable useful life. This means that it must
be something that wears out, decays, gets used
up, becomes obsolete, or loses its value from
natural causes.
What Rental Property
Cannot Be Depreciated?
Certain property cannot be depreciated. This in-
cludes land and certain excepted property.
Land. You cannot depreciate the cost of land
because land generally does not wear out, be-
come obsolete, or get used up. But if it does,
the loss is accounted for upon disposition. The
costs of clearing, grading, planting, and land-
scaping are usually all part of the cost of land
and cannot be depreciated. You may, however,
be able to depreciate certain land preparation
costs if the costs are so closely associated with
other depreciable property that you can deter-
mine a life for them along with the life of the as-
sociated property.
Example. You built a new house to use as
a rental and paid for grading, clearing, seeding,
and planting bushes and trees. Some of the
bushes and trees were planted right next to the
house, while others were planted around the
outer border of the lot. If you replace the house,
you would have to destroy the bushes and trees
right next to it. These bushes and trees are
closely associated with the house, so they have
a determinable useful life. Therefore, you can
depreciate them. Add your other land prepara-
tion costs to the basis of your land because
they have no determinable life and you cannot
depreciate them.
Excepted property. Even if the property
meets all the requirements listed earlier under
What Rental Property Can Be Depreciated, you
cannot depreciate the following property.
Property placed in service and disposed of
(or taken out of business use) in the same
year.
Equipment used to build capital improve-
ments. You must add otherwise allowable
depreciation on the equipment during the
period of construction to the basis of your
improvements.
For more information, see chapter 1 of Pub.
946.
When Does Depreciation
Begin and End?
You begin to depreciate your rental property
when you place it in service for the production
of income. You stop depreciating it either when
you have fully recovered your cost or other ba-
sis, or when you retire it from service, whichever
happens first.
Placed in Service
You place property in service in a rental activity
when it is ready and available for a specific use
in that activity. Even if you are not using the
property, it is in service when it is ready and
available for its specific use.
Example 1. On November 22 of last year,
you purchased a dishwasher for your rental
property. The appliance was delivered on De-
cember 7, but was not installed and ready for
use until January 3 of this year. Because the
dishwasher was not ready for use last year, it is
not considered placed in service until this year.
If the appliance had been installed and
ready for use when it was delivered in Decem-
ber of last year, it would have been considered
placed in service in December, even if it was
not actually used until this year.
Example 2. On April 6, you purchased a
house to use as residential rental property. You
made extensive repairs to the house and had it
ready for rent on July 5. You began to advertise
the house for rent in July and actually rented it
beginning September 1. The house is consid-
ered placed in service in July when it was ready
and available for rent. You can begin to depreci-
ate the house in July.
Example 3. You moved from your home in
July. During August and September you made
several repairs to the house. On October 1, you
listed the property for rent with a real estate
company, which rented it on December 1. The
property is considered placed in service on Oc-
tober 1, the date when it was available for rent.
Conversion to business use. If you place
property in service in a personal activity, you
cannot claim depreciation. However, if you
change the property's use to business or the
production of income, you can begin to depreci-
ate it at the time of the change. You place the
property in service for business or income-pro-
ducing use on the date of the change.
Example. You bought a house and used it
as your personal home several years before
you converted it to rental property. Although its
specific use was personal and no depreciation
was allowable, you placed the home in service
when you began using it as your home. You can
begin to claim depreciation in the year you con-
verted it to rental property because at that time
its use changed to the production of income.
Idle Property
Continue to claim a deduction for depreciation
on property used in your rental activity even if it
is temporarily idle (not in use). For example, if
you must make repairs after a tenant moves
out, you still depreciate the rental property dur-
ing the time it is not available for rent.
Cost or Other Basis
Fully Recovered
You must stop depreciating property when the
total of your yearly depreciation deductions
equals your cost or other basis of your property.
For this purpose, your yearly depreciation de-
ductions include any depreciation that you were
allowed to claim, even if you did not claim it.
See Basis of Depreciable Property, later.
Retired From Service
You stop depreciating property when you retire
it from service, even if you have not fully recov-
ered its cost or other basis. You retire property
from service when you permanently withdraw it
from use in a trade or business or from use in
the production of income because of any of the
following events.
You sell or exchange the property.
You convert the property to personal use.
You abandon the property.
The property is destroyed.
Depreciation Methods
Generally, you must use the Modified Acceler-
ated Cost Recovery System (MACRS) to de-
preciate residential rental property placed in
service after 1986.
If you placed rental property in service be-
fore 1987, you are using one of the following
methods.
Accelerated Cost Recovery System–
(ACRS) for property placed in service after
1980 but before 1987.
Straight line or declining balance method
over the useful life of property placed in
service before 1981.
See MACRS Depreciation, later, for more infor-
mation.
Rental property placed in service before
2016. Continue to use the same method of fig-
uring depreciation that you used in the past.
Use of real property changed. Generally,
you must use MACRS to depreciate real prop-
erty that you acquired for personal use before
1987 and changed to business or income-pro-
ducing use after 1986. This includes your
residence that you changed to rental use. See
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Page 6 Chapter 2 Depreciation of Rental Property
Property Owned or Used in 1986 in Pub. 946,
chapter 1, for those situations in which MACRS
is not allowed.
Improvements made after 1986. Treat an im-
provement made after 1986 to property you
placed in service before 1987 as separate de-
preciable property. As a result, you can depreci-
ate that improvement as separate property un-
der MACRS if it is the type of property that
otherwise qualifies for MACRS depreciation.
For more information about improvements, see
Additions or improvements to property, later in
this chapter under Recovery Periods Under
GDS.
This publication discusses MACRS de-
preciation only. If you need information
about depreciating property placed in
service before 1987, see Pub. 534.
Basis of Depreciable
Property
The basis of property used in a rental activity is
generally its adjusted basis when you place it in
service in that activity. This is its cost or other
basis when you acquired it, adjusted for certain
items occurring before you place it in service in
the rental activity.
If you depreciate your property under
MACRS, you may also have to reduce your ba-
sis by certain deductions and credits with re-
spect to the property.
Basis and adjusted basis are explained in
the following discussions.
If you used the property for personal
purposes before changing it to rental
use, its basis for depreciation is the
lesser of its adjusted basis or its fair market
value when you change it to rental use. See Ba-
sis of Property Changed to Rental Use in chap-
ter 4.
Cost Basis
The basis of property you buy is usually its cost.
The cost is the amount you pay for it in cash, in
debt obligation, in other property, or in services.
Your cost also includes amounts you pay for:
Sales tax charged on the purchase (but
see Exception next),
Freight charges to obtain the property, and
Installation and testing charges.
Exception. If you deducted state and local
general sales taxes as an itemized deduction
on Schedule A (Form 1040), do not include
those sales taxes as part of your cost basis.
Such taxes were deductible before 1987 and
after 2003.
Loans with low or no interest. If you buy
property on any payment plan that charges little
or no interest, the basis of your property is your
stated purchase price, less the amount consid-
ered to be unstated interest. See Unstated In-
terest and Original Issue Discount (OID) in Pub.
537, Installment Sales.
Real property. If you buy real property, such
as a building and land, certain fees and other
CAUTION
!
CAUTION
!
expenses you pay are part of your cost basis in
the property.
Real estate taxes. If you buy real property
and agree to pay real estate taxes on it that
were owed by the seller and the seller does not
reimburse you, the taxes you pay are treated as
part of your basis in the property. You cannot
deduct them as taxes paid.
If you reimburse the seller for real estate
taxes the seller paid for you, you can usually
deduct that amount. Do not include that amount
in your basis in the property.
Settlement fees and other costs. The fol-
lowing settlement fees and closing costs for
buying the property are part of your basis in the
property.
Abstract fees.
Charges for installing utility services.
Legal fees.
Recording fees.
Surveys.
Transfer taxes.
Title insurance.
Any amounts the seller owes that you
agree to pay, such as back taxes or inter-
est, recording or mortgage fees, charges
for improvements or repairs, and sales
commissions.
The following are settlement fees and clos-
ing costs you cannot include in your basis in the
property.
1. Fire insurance premiums.
2. Rent or other charges relating to occu-
pancy of the property before closing.
3. Charges connected with getting or refi-
nancing a loan, such as:
a. Points (discount points, loan origina-
tion fees),
b. Mortgage insurance premiums,
c. Loan assumption fees,
d. Cost of a credit report, and
e. Fees for an appraisal required by a
lender.
Also, do not include amounts placed in es-
crow for the future payment of items such as
taxes and insurance.
Assumption of a mortgage. If you buy
property and become liable for an existing mort-
gage on the property, your basis is the amount
you pay for the property plus the amount re-
maining to be paid on the mortgage.
Example. You buy a building for $60,000
cash and assume a mortgage of $240,000 on it.
Your basis is $300,000.
Separating cost of land and buildings. If
you buy buildings and your cost includes the
cost of the land on which they stand, you must
divide the cost between the land and the build-
ings to figure the basis for depreciation of the
buildings. The part of the cost that you allocate
to each asset is the ratio of the fair market value
of that asset to the fair market value of the
whole property at the time you buy it.
If you are not certain of the fair market val-
ues of the land and the buildings, you can di-
vide the cost between them based on their as-
sessed values for real estate tax purposes.
Example. You buy a house and land for
$200,000. The purchase contract does not
specify how much of the purchase price is for
the house and how much is for the land.
The latest real estate tax assessment on the
property was based on an assessed value of
$160,000, of which $136,000 was for the house
and $24,000 was for the land.
You can allocate 85% ($136,000 ÷
$160,000) of the purchase price to the house
and 15% ($24,000 ÷ $160,000) of the purchase
price to the land.
Your basis in the house is $170,000 (85% of
$200,000) and your basis in the land is $30,000
(15% of $200,000).
Basis Other Than Cost
You cannot use cost as a basis for property that
you received:
In return for services you performed;
In an exchange for other property;
As a gift;
From your spouse, or from your former
spouse as the result of a divorce; or
As an inheritance.
If you received property in one of these
ways, see Pub. 551 for information on how to
figure your basis.
Adjusted Basis
To figure your property's basis for depreciation,
you may have to make certain adjustments (in-
creases and decreases) to the basis of the
property for events occurring between the time
you acquired the property and the time you
placed it in service for business or the produc-
tion of income. The result of these adjustments
to the basis is the adjusted basis.
Increases to basis. You must increase the
basis of any property by the cost of all items
properly added to a capital account. These in-
clude the following.
The cost of any additions or improvements
made before placing your property into
service as a rental that have a useful life of
more than 1 year.
Amounts spent after a casualty to restore
the damaged property.
The cost of extending utility service lines to
the property.
Legal fees, such as the cost of defending
and perfecting title, or settling zoning is-
sues.
Additions or improvements. Add to the
basis of your property the amount an addition or
improvement actually cost you, including any
amount you borrowed to make the addition or
improvement. This includes all direct costs,
such as material and labor, but does not include
your own labor. It also includes all expenses re-
lated to the addition or improvement.
For example, if you had an architect draw up
plans for remodeling your property, the archi-
tect's fee is a part of the cost of the remodeling.
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Chapter 2 Depreciation of Rental Property Page 7
Or, if you had your lot surveyed to put up a
fence, the cost of the survey is a part of the cost
of the fence.
Keep separate accounts for depreciable ad-
ditions or improvements made after you place
the property in service in your rental activity. For
information on depreciating additions or im-
provements, see Additions or improvements to
property, later in this chapter under Recovery
Periods Under GDS.
The cost of landscaping improvements
is usually treated as an addition to the
basis of the land, which is not depreci-
able. However, see What Rental Property Can-
not Be Depreciated, earlier.
Assessments for local improvements.
Assessments for items which tend to increase
the value of property, such as streets and side-
walks, must be added to the basis of the prop-
erty. For example, if your city installs curbing on
the street in front of your house, and assesses
you and your neighbors for its cost, you must
add the assessment to the basis of your prop-
erty. Also add the cost of legal fees paid to ob-
tain a decrease in an assessment levied against
property to pay for local improvements. You
cannot deduct these items as taxes or depreci-
ate them.
However, you can deduct assessments for
the purpose of maintenance or repairs or for the
purpose of meeting interest charges related to
the improvements. Do not add them to your ba-
sis in the property.
Deducting vs. capitalizing costs. Do not
add to your basis costs you can deduct as cur-
rent expenses. However, there are certain costs
you can choose either to deduct or to capitalize.
If you capitalize these costs, include them in
your basis. If you deduct them, do not include
them in your basis.
The costs you may choose to deduct or cap-
italize include carrying charges, such as interest
and taxes, that you must pay to own property.
For more information about deducting or
capitalizing costs and how to make the election,
see Carrying Charges in Pub. 535, chapter 7.
Decreases to basis. You must decrease the
basis of your property by any items that repre-
sent a return of your cost. These include the fol-
lowing.
Insurance or other payment you receive as
the result of a casualty or theft loss.
Casualty loss not covered by insurance for
which you took a deduction.
Amount(s) you receive for granting an
easement.
Residential energy credits you were al-
lowed before 1986, or after 2005, if you
added the cost of the energy items to the
basis of your home.
Exclusion from income of subsidies for en-
ergy conservation measures.
Special depreciation allowance claimed on
qualified property.
Depreciation you deducted, or could have
deducted, on your tax returns under the
method of depreciation you chose. If you
did not deduct enough or deducted too
much in any year, see Depreciation under
Decreases to Basis in Pub. 551.
CAUTION
!
If your rental property was previously used
as your main home, you must also decrease the
basis by the following.
Gain you postponed from the sale of your
main home before May 7, 1997, if the re-
placement home was converted to your
rental property.
District of Columbia first-time homebuyer
credit allowed on the purchase of your
main home after August 4, 1997 and be-
fore January 1, 2012.
Amount of qualified principal residence in-
debtedness discharged on or after January
1, 2007.
Special Depreciation
Allowance
For 2016, some properties used in connection
with residential real property activities may
qualify for a special depreciation allowance.
This allowance is figured before you figure your
regular depreciation deduction. See Pub. 946,
chapter 3, for details. Also see the instructions
for Form 4562, line 14.
If you qualify for, but choose not to take, a
special depreciation allowance, you must attach
a statement to your return. The details of this
election are in Pub. 946, chapter 3, and the in-
structions for Form 4562, line 14.
MACRS Depreciation
Most business and investment property placed
in service after 1986 is depreciated using
MACRS.
This section explains how to determine
which MACRS depreciation system applies to
your property. It also discusses other informa-
tion you need to know before you can figure de-
preciation under MACRS. This information in-
cludes the property's:
Recovery class,
Applicable recovery period,
Convention,
Placed-in-service date,
Basis for depreciation, and
Depreciation method.
Depreciation Systems
MACRS consists of two systems that determine
how you depreciate your property—the General
Depreciation System (GDS) and the Alternative
Depreciation System (ADS). You must use
GDS unless you are specifically required by law
to use ADS or you elect to use ADS.
Excluded Property
You cannot use MACRS for certain personal
property (such as furniture or appliances)
placed in service in your rental property in 2016
if it had been previously placed in service be-
fore 1987, when MACRS became effective.
In most cases, personal property is exclu-
ded from MACRS if you (or a person related to
you) owned or used it in 1986 or if your tenant is
a person (or someone related to the person)
who owned or used it in 1986. However, the
property is not excluded if your 2016 deduction
under MACRS (using a half-year convention) is
less than the deduction you would have under
ACRS. For more information, see
What Method
Can You Use To Depreciate Your Property? in
Pub. 946, chapter 1.
Electing ADS
If you choose, you can use the ADS method for
most property. Under ADS, you use the straight
line method of depreciation.
The election of ADS for one item in a class
of property generally applies to all property in
that class placed in service during the tax year
of the election. However, the election applies on
a property-by-property basis for residential
rental property and nonresidential real property.
If you choose to use ADS for your residential
rental property, the election must be made in
the first year the property is placed in service.
Once you make this election, you can never re-
voke it.
For property placed in service during 2016,
you make the election to use ADS by entering
the depreciation on Form 4562, Part III, Sec-
tion C, line 20c.
Property Classes Under GDS
Each item of property that can be depreciated
under MACRS is assigned to a property class,
determined by its class life. The property class
generally determines the depreciation method,
recovery period, and convention.
The property classes under GDS are:
3-year property,
5-year property,
7-year property,
10-year property,
15-year property,
20-year property,
Nonresidential real property, and
Residential rental property.
Under MACRS, property that you placed in
service during 2016 in your rental activities gen-
erally falls into one of the following classes.
5year property. This class includes com-
puters and peripheral equipment, office
machinery (typewriters, calculators, cop-
iers, etc.), automobiles, and light trucks.
This class also includes appliances,
carpeting, and furniture used in a residen-
tial rental real estate activity.
Depreciation is limited on automobiles
and other property used for transportation;
computers and related peripheral equip-
ment; and property of a type generally
used for entertainment, recreation, or
amusement. See chapter 5 of Pub. 946.
7year property. This class includes of-
fice furniture and equipment (desks, file
cabinets, and similar items). This class
also includes any property that does not
have a class life and that has not been
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Page 8 Chapter 2 Depreciation of Rental Property
designated by law as being in any other
class.
15year property. This class includes
roads, fences, and shrubbery (if deprecia-
ble).
Residential rental property. This class
includes any real property that is a rental
building or structure (including a mobile
home) for which 80% or more of the gross
rental income for the tax year is from dwell-
ing units. It does not include a unit in a ho-
tel, motel, inn, or other establishment
where more than half of the units are used
on a transient basis. If you live in any part
of the building or structure, the gross rental
income includes the fair rental value of the
part you live in.
The other property classes do not gen-
erally apply to property used in rental
activities. These classes are not dis-
cussed in this publication. See Pub. 946 for
more information.
Recovery Periods
Under GDS
The recovery period of property is the number
of years over which you recover its cost or other
basis. The recovery periods are generally lon-
ger under ADS than GDS.
The recovery period of property depends on
its property class. Under GDS, the recovery pe-
riod of an asset is generally the same as its
property class.
Class lives and recovery periods for most
assets are listed in Appendix B of Pub. 946.
See Table 2-1 for recovery periods of property
commonly used in residential rental activities.
Qualified Indian reservation property.
Shorter recovery periods are provided under
MACRS for qualified Indian reservation prop-
erty placed in service on Indian reservations.
For more information, see chapter 4 of Pub.
946.
Additions or improvements to property.
Treat additions or improvements you make to
your depreciable rental property as separate
property items for depreciation purposes.
The property class and recovery period of
the addition or improvement is the one that
would apply to the original property if you had
placed it in service at the same time as the ad-
dition or improvement.
The recovery period for an addition or im-
provement to property begins on the later of:
The date the addition or improvement is
placed in service, or
The date the property to which the addition
or improvement was made is placed in
service.
Example. You own a residential rental
house that you have been renting since 1986
and depreciating under ACRS. You built an ad-
dition onto the house and placed it in service in
2016. You must use MACRS for the addition.
Under GDS, the addition is depreciated as resi-
dential rental property over 27.5 years.
CAUTION
!
Conventions
A convention is a method established under
MACRS to set the beginning and end of the re-
covery period. The convention you use deter-
mines the number of months for which you can
claim depreciation in the year you place prop-
erty in service and in the year you dispose of
the property.
Mid-month convention. A mid-month conven-
tion is used for all residential rental property and
nonresidential real property. Under this conven-
tion, you treat all property placed in service, or
disposed of, during any month as placed in
service, or disposed of, at the midpoint of that
month.
Mid-quarter convention. A mid-quarter con-
vention must be used if the mid-month conven-
tion does not apply and the total depreciable
basis of MACRS property placed in service in
the last 3 months of a tax year (excluding non-
residential real property, residential rental prop-
erty, and property placed in service and dis-
posed of in the same year) is more than 40% of
the total basis of all such property you place in
service during the year.
Under this convention, you treat all property
placed in service, or disposed of, during any
quarter of a tax year as placed in service, or dis-
posed of, at the midpoint of the quarter.
Example. During the tax year, Tom pur-
chased the following items to use in his rental
property. He elects not to claim the special de-
preciation allowance discussed earlier.
A dishwasher for $400 that he placed in
service in January.
Used furniture for $100 that he placed in
service in September.
A refrigerator for $800 that he placed in
service in October.
Tom uses the calendar year as his tax year.
The total basis of all property placed in service
that year is $1,300. The $800 basis of the refrig-
erator placed in service during the last 3 months
of his tax year exceeds $520 (40% × $1,300).
Tom must use the mid-quarter convention in-
stead of the half-year convention for all three
items.
Half-year convention. The half-year conven-
tion is used if neither the mid-quarter conven-
tion nor the mid-month convention applies. Un-
der this convention, you treat all property
MACRS Recovery Periods for
Property Used in
Rental Activities
Table 2-1.
Keep for Your Records
MACRS Recovery Period
Type of Property
General
Depreciation
System
Alternative
Depreciation
System
Computers and their peripheral equipment ............. 5 years 5 years
Office machinery, such as:
Typewriters
Calculators
Copiers .................................... 5 years 6 years
Automobiles ................................... 5 years 5 years
Light trucks .................................... 5 years 5 years
Appliances, such as:
Stoves
Refrigerators ................................ 5 years 9 years
Carpets ....................................... 5 years 9 years
Furniture used in rental property ..................... 5 years 9 years
Office furniture and equipment, such as:
Desks
Files ...................................... 7 years 10 years
Any property that does not have a class life and that has not
been designated by law as being in any other class
....... 7 years 12 years
Roads ........................................ 15 years 20 years
Shrubbery ..................................... 15 years 20 years
Fences ....................................... 15 years 20 years
Residential rental property (buildings or structures) and
structural components such as furnaces, waterpipes, venting,
etc.
.......................................... 27.5 years 40 years
Additions and improvements, such as a new roof ........ The same recovery period as
that of the property to which
the addition or improvement is
made, determined as if the
property were placed in
service at the same time as
the addition or improvement.
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Chapter 2 Depreciation of Rental Property Page 9
placed in service, or disposed of, during a tax
year as placed in service, or disposed of, at the
midpoint of that tax year.
If this convention applies, you deduct a half
year of depreciation for the first year and the
last year that you depreciate the property. You
deduct a full year of depreciation for any other
year during the recovery period.
Figuring Your Depreciation
Deduction
You can figure your MACRS depreciation de-
duction in one of two ways. The deduction is
substantially the same both ways. You can fig-
ure the deduction using either:
The depreciation method and convention
that apply over the recovery period of the
property, or
The percentage from the MACRS percent-
age tables.
In this publication we will use the percent-
age tables. For instructions on how to compute
the deduction, see chapter 4 of Pub. 946.
Residential rental property. You must use
the straight line method and a mid-month con-
vention for residential rental property. In the first
year that you claim depreciation for residential
rental property, you can claim depreciation only
for the number of months the property is in use.
Use the mid-month convention (explained un-
der Conventions, earlier).
5-, 7-, or 15-year property. For property in the
5- or 7-year class, use the 200% declining bal-
ance method and a half-year convention. How-
ever, in limited cases you must use the
mid-quarter convention, if it applies. For prop-
erty in the 15-year class, use the 150% declin-
ing balance method and a half-year convention.
You can also choose to use the 150% de-
clining balance method for property in the 5- or
7-year class. The choice to use the 150%
method for one item in a class of property ap-
plies to all property in that class that is placed in
service during the tax year of the election. You
make this election on Form 4562. In Part III, col-
umn (f), enter “150 DB.” Once you make this
election, you cannot change to another method.
If you use either the 200% or 150% declin-
ing balance method, figure your deduction us-
ing the straight line method in the first tax year
that the straight line method gives you an equal
or larger deduction.
You can also choose to use the straight line
method with a half-year or mid-quarter conven-
tion for 5-, 7-, or 15-year property. The choice to
use the straight line method for one item in a
class of property applies to all property in that
class that is placed in service during the tax
year of the election. You elect the straight line
method on Form 4562. In Part III, column (f),
enter “S/L.” Once you make this election, you
cannot change to another method.
MACRS Percentage Tables
You can use the percentages in Table 2-2 to
compute annual depreciation under MACRS.
The tables show the percentages for the first
few years or until the change to the straight line
method is made. See Appendix A of Pub. 946
for complete tables. The percentages in Tables
2-2a, 2-2b, and 2-2c make the change from de-
clining balance to straight line in the year that
straight line will give a larger deduction.
If you elect to use the straight line method
for 5-, 7-, or 15-year property, or the 150% de-
clining balance method for 5- or 7-year prop-
erty, use the tables in Appendix A of Pub. 946.
How to use the percentage tables. You must
apply the table rates to your property's
unadjus-
ted basis (defined below) each year of the re-
covery period.
Once you begin using a percentage table to
figure depreciation, you must continue to use it
for the entire recovery period unless there is an
adjustment to the basis of your property for a
reason other than:
1. Depreciation allowed or allowable, or
2. An addition or improvement that is depre-
ciated as a separate item of property.
If there is an adjustment for any reason
other than (1) or (2), for example, because of a
deductible casualty loss, you can no longer use
the table. For the year of the adjustment and for
the remaining recovery period, figure deprecia-
tion using the property's adjusted basis at the
end of the year and the appropriate deprecia-
tion method, as explained earlier under Figuring
Your Depreciation Deduction. See Figuring the
Deduction Without Using the Tables in Pub.
946, chapter 4.
Unadjusted basis. This is the same basis
you would use to figure gain on a sale (see Ba-
sis of Depreciable Property, earlier), but without
reducing your original basis by any MACRS de-
preciation taken in earlier years.
However, you do reduce your original basis
by other amounts claimed on the property, in-
cluding:
Any amortization,
Any section 179 deduction, and
Any special depreciation allowance.
For more information, see chapter 4 of Pub.
946.
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Page 10 Chapter 2 Depreciation of Rental Property
Tables 2-2a, 2-2b, and 2-2c. The percen-
tages in these tables take into account the
half-year and mid-quarter conventions. Use Ta-
ble 2-2a for 5-year property, Table 2-2b for
7-year property, and Table 2-2c for 15-year
property. Use the percentage in the second col-
umn (half-year convention) unless you are re-
quired to use the mid-quarter convention (ex-
plained earlier). If you must use the mid-quarter
convention, use the column that corresponds to
the calendar year quarter in which you placed
the property in service.
Example 1. You purchased a stove and re-
frigerator and placed them in service in June.
Your basis in the stove is $600 and your basis
in the refrigerator is $1,000. Both are 5-year
property. Using the half-year convention col-
umn in Table 2-2a, the depreciation percentage
for Year 1 is 20%. For that year your deprecia-
tion deduction is $120 ($600 × 0.20) for the
stove and $200 ($1,000 × 0.20) for the refriger-
ator.
For Year 2, the depreciation percentage is
32%. That year's depreciation deduction will be
$192 ($600 × 0.32) for the stove and $320
($1,000 × 0.32) for the refrigerator.
Example 2. Assume the same facts as in
Example 1, except you buy the refrigerator in
October instead of June. Since the refrigerator
was placed in service in the last 3 months of the
tax year, and its basis ($1,000) is more than
40% of the total basis of all property placed in
service during the year ($1,600 × 0.40 = $640),
you are required to use the mid-quarter conven-
tion to figure depreciation on both the stove and
refrigerator.
Because you placed the refrigerator in serv-
ice in October, you use the fourth quarter col-
umn of Table 2-2a and find the depreciation
percentage for Year 1 is 5%. Your depreciation
deduction for the refrigerator is $50 ($1,000 x
0.05).
Because you placed the stove in service in
June, you use the second quarter column of Ta-
ble 2-2a and find the depreciation percentage
for Year 1 is 25%. For that year, your deprecia-
tion deduction for the stove is $150 ($600 x
0.25).
Table 2-2d. Use this table when you are using
the GDS 27.5 year option for residential rental
property. Find the row for the month that you
placed the property in service. Use the percen-
tages listed for that month to figure your depre-
ciation deduction. The mid-month convention is
taken into account in the percentages shown in
the table. Continue to use the same row
(month) under the column for the appropriate
year.
Example. You purchased a single family
rental house for $185,000 and placed it in serv-
ice on February 8. The sales contract showed
that the building cost $160,000 and the land
cost $25,000. Your basis for depreciation is its
original cost, $160,000. This is the first year of
service for your residential rental property and
you decide to use GDS which has a recovery
period of 27.5 years. Using Table 2-2d, you find
that the percentage for property placed in serv-
ice in February of Year 1 is 3.182%. That year's
depreciation deduction is $5,091 ($160,000 x
0.03182).
Figuring MACRS
Depreciation Under ADS
Table 2-1, earlier, shows the ADS recovery pe-
riods for property used in rental activities.
See Appendix B in Pub. 946 for other prop-
erty. If your property is not listed in Appendix B,
it is considered to have no class life. Under
ADS, personal property with no class life is de-
preciated using a recovery period of 12 years.
Use the mid-month convention for residen-
tial rental property and nonresidential real prop-
erty. For all other property, use the half-year or
mid-quarter convention, as appropriate.
See Pub. 946 for ADS depreciation tables.
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Chapter 2 Depreciation of Rental Property Page 11
Claiming the Correct
Amount of Depreciation
You should claim the correct amount of depreci-
ation each tax year. If you did not claim all the
depreciation you were entitled to deduct, you
must still reduce your basis in the property by
the full amount of depreciation that you could
have deducted. For more information, see
De-
preciation under Decreases to Basis in Pub.
551.
If you deducted an incorrect amount of de-
preciation for property in any year, you may be
able to make a correction by filing Form 1040X,
Amended U.S. Individual Income Tax Return. If
you are not allowed to make the correction on
an amended return, you can change your ac-
counting method to claim the correct amount of
depreciation.
Filing an amended return. You can file an
amended return to correct the amount of depre-
ciation claimed for any property in any of the fol-
lowing situations.
You claimed the incorrect amount because
of a mathematical error made in any year.
You claimed the incorrect amount because
of a posting error made in any year.
You have not adopted a method of ac-
counting for property placed in service by
you in tax years ending after December 29,
2003.
You claimed the incorrect amount on prop-
erty placed in service by you in tax years
ending before December 30, 2003.
Generally, you adopt a method of account-
ing for depreciation by using a permissible
method of determining depreciation when you
file your first tax return for the property used in
your rental activity. This also occurs when you
use the same impermissible method of deter-
mining depreciation (for example, using the
wrong MACRS recovery period) in two or more
consecutively filed tax returns.
If an amended return is allowed, you must
file it by the later of the following dates.
3 years from the date you filed your original
return for the year in which you did not de-
duct the correct amount. A return filed be-
fore an unextended due date is considered
filed on that due date.
2 years from the time you paid your tax for
that year.
Changing your accounting method. To
change your accounting method, you generally
must file Form 3115, Application for Change in
Accounting Method, to get the consent of the
IRS. In some instances, that consent is auto-
matic. For more information, see Changing
Your Accounting Method in Pub. 946,
chapter 1.
3.
Reporting
Rental Income,
Expenses, and
Losses
Figuring the net income or loss for a residential
rental activity may involve more than just listing
the income and deductions on Schedule E
(Form 1040). There are activities that do not
qualify to use Schedule E, such as when the ac-
tivity is not engaged in to make a profit or when
you provide substantial services in conjunction
with the property.
There are also the limitations that may need to
be applied if you have a net loss on Schedule E.
There are two: (1) the limitation based on the
amount of investment you have at risk in your
rental activity, and (2) the special limits imposed
on passive activities.
You may also have a gain or loss related to your
rental property from a casualty or theft. This is
considered separately from the income and ex-
pense information you report on Schedule E.
Which Forms To Use
The basic form for reporting residential rental in-
come and expenses is Schedule E (Form
1040). However, do not use that schedule to re-
port a not-for-profit activity. See Not Rented for
Profit, in chapter 4. There are also other rental
situations in which forms other than Schedule E
would be used.
Schedule E (Form 1040)
If you rent buildings, rooms, or apartments, and
provide basic services such as heat and light,
trash collection, etc., you normally report your
rental income and expenses on Schedule E,
Part I.
List your total income, expenses, and depre-
ciation for each rental property. Be sure to enter
the number of fair rental and personal use days
on line 2.
If you have more than three rental or royalty
properties, complete and attach as many
Schedules E as are needed to list the proper-
ties. Complete lines 1 and 2 for each property.
However, fill in lines 23a through 26 on only one
Schedule E.
On Schedule E, page 1, line 18, enter the
depreciation you are claiming for each property.
To find out if you need to attach Form 4562, see
Form 4562, later.
If you have a loss from your rental real es-
tate activity, you also may need to complete
one or both of the following forms.
Form 6198, At-Risk Limitations. See
At-Risk Rules, later. Also see Pub. 925.
Form 8582, Passive Activity Loss Limita-
tions. See Passive Activity Limits, later.
Page 2 of Schedule E is used to report in-
come or loss from partnerships, S corporations,
estates, trusts, and real estate mortgage invest-
ment conduits. If you need to use page 2 of
Schedule E, be sure to use page 2 of the same
Schedule E you used to enter your rental activ-
ity on page 1. Also, include the amount from
line 26 (Part I) in the “Total income or (loss)” on
line 41 (Part V).
Form 4562. You must complete and attach
Form 4562 for rental activities only if you are
claiming:
Depreciation, including the special depre-
ciation allowance, on property placed in
service during 2016;
Depreciation on listed property (such as a
car), regardless of when it was placed in
service; or
Any other car expenses, including the
standard mileage rate or lease expenses.
Otherwise, figure your depreciation on your own
worksheet. You do not have to attach these
computations to your return, but you should
keep them in your records for future reference.
See Pub. 946 for information on preparing
Form 4562.
Schedule C (Form 1040),
Profit or Loss From Business
Generally, Schedule C is used when you pro-
vide substantial services in conjunction with the
property or the rental is part of a trade or busi-
ness as a real estate dealer.
Providing substantial services. If you pro-
vide substantial services that are primarily for
your tenant's convenience, such as regular
cleaning, changing linen, or maid service, you
report your rental income and expenses on
Schedule C (Form 1040), Profit or Loss From
Business, or Schedule C-EZ (Form 1040), Net
Profit From Business. Use Form 1065, U.S. Re-
turn of Partnership Income, if your rental activity
is a partnership (including a partnership with
your spouse unless it is a qualified joint ven-
ture). Substantial services do not include the
furnishing of heat and light, cleaning of public
areas, trash collection, etc. For information, see
Pub. 334, Tax Guide for Small Business. Also,
you may have to pay self-employment tax on
your rental income using Schedule SE (Form
1040), Self-Employment Tax. For a discussion
of “substantial services,” see Real Estate Rents
in Pub. 334, chapter 5.
Qualified Joint Venture
If you and your spouse each materially partici-
pate (see Material participation under Passive
Activity Limits, later) as the only members of a
jointly owned and operated real estate busi-
ness, and you file a joint return for the tax year,
you can make a joint election to be treated as a
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Page 12 Chapter 3 Reporting Rental Income, Expenses, and Losses
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