What Is Depreciation?
Depreciation is a method used to determine how much of the assets (e.g. your home) value has been used up. For Airbnb rental owners, the cost of buying or improving your home can be depreciated. Depreciating these assets in accordance with the rules from the IRS will allow you to claim portion of the cost as a deduction on your taxes each year.
It is important to note that these depreciation rules only apply if you own your home. According to the IRS, the property must not be rented or borrowed from someone that is not you. You must also be able to determine a definable useful life for your home, which is the amount of time that the property will be viable for business, and this useful life must be longer than one year.
When Does Depreciation Begin and End?
The depreciation of the property should begin when your home has been placed in service, which means when your home is ready and available for use. When you place your home for use as an Airbnb rental, you can begin to depreciate your property. For example, let's assume that you put your home on Airbnb in mid December 2017, but it didn't rent it out until January 2018. You may begin to depreciate your property as of December.
In order to be considered as your home, you must use the property for personal use for the greater of:
- 14 days
- 10% of the total days that you've rented the property out to others at fair market value.
If your home is rented out for less than 15 days per year, you are not required to report the income to the IRS. Any qualified casualty loss that you incur, such as mortgage interest or property taxes would then be reported on Schedule A as an itemized deduction.
However, if you rent your home out for more than 15 days in a year, you must report the rental income to the IRS. In order to report the expenses you incurred, you must divide up the expenses between the portion that resulted from personal use of your home and rental use your home.
The deductible rental expenses are also not permitted to be greater than the gross rental income that you earned. The expenses must also be divided based on the number of days that you used the home for personal use and rental use, as well as, the portion of the home that was rented versus your personal non-rental space.
However, you are permitted to continue to claim a deduction for depreciation on property that is used in rental activity even if the property is temporarily idle. For example, if you need to make repairs after a recent Airbnb booking, you can still depreciate the rental property even though the property isn't actually available for rent.
You must stop depreciating your home when you have either recovered the full cost or when the property is retired from being in service as an Airbnb rental, whichever event occurs first. A rental property is considered to be permanently retired once you withdraw it from the Airbnb platform, sell or exchange it, convert it to personal use only, abandon it or it is destroyed.
Report Deductions Via IRS Form 4562
In oder to deduct your home as a business expense using depreciation in the most tax-advantageous way, you will need to report your rental income and expenses using Schedule C. However, by doing so your income will also be subject to self-employment taxes. Most people who use Airbnb are running a business and by default are required to file under Schedule C.
If you plan to claim any depreciation deductions, these deductions will be reported on IRS Form 4562, Depreciation and Amortization. The number of deductions you are allowed depends on type of property. Make sure that you keep copies of all of the Form 4562's that you've filed in recent years so that you can keep track of your prior deductions.
Deductions on Assets Purchased Solely for Your AirBnB Business
For assets that you have purchased solely for the purpose of your AirBnB business, you may be able to use the Section 179 deduction, which allows you to take the full deduction for that asset in the first year, rather than over the life of the property.
Keep in mind that in order to qualify for the Section 179 Deduction, the equipment must be purchased and put into use between January 1 and December 31 of the tax year that you are planning to claim the Section 179 Deduction for.
These items include:
- Equipment purchased for business use (appliances, carpet)
- Vehicles used for business
- Tangible personal property used for business
- Equipment that is used for both business and personal use
You cannot depreciate the cost of land because land generally does not wear out or get used up. In addition, you cannot depreciate property that has been put into service and taken out of service during the same year.
There are certain types of property that you may not depreciate under 179, such as air conditioning or heating units, swimming pools, paved parking areas, and solar energy equipment. Capital improvements are exempted because Section 179 is not permitted to be used for property that is acquired for the sole purpose of producing rental income. The complete list of property that is exempted can be found here.
It is also important to note that while used equipment, namely equipment that you recently purchased used, qualifies for Section 179, it does not qualify for the Bonus Depreciation.
Safe Harbor For Improvements and Repairs
In 2014, the IRS established a safe harbor rule that allows Airbnb hosts and other landlords to deduct expenses that might otherwise be considered improvements and would need to be depreciated. If you qualify for under IRS Reg. §1.263(a)-3h you can deduct your annual expenses for repairs, improvements, maintenance, and other costs for business real property by attaching a simple election statement to your tax return.
To qualify, your property must have an unadjusted basis of $1 million or less. The total amount of your expenses must also not exceed $10,000 or 2% of the unadjusted basis of the property on a per building basis. Finally, your annual gross receipts must not exceed $10 million during the three preceding tax years. This can represent an incredible deduction by allowing expense treatment to improvements made to your Airbnb rental.
What Is Depreciation Recapture?
Depreciation recapture is the gain that results from the sale of your home which must be reported as income. Depreciation recapture is assessed when the sale price of the home is greater than the tax basis or adjusted cost basis. Depreciation recapture is reported using Form 4797, Sales of Business Property.
The idea behind depreciation is that the asset that you’re depreciating will lose value each year. However, with real estate this isn't the case as real estate typically increases in value. If you sell your property for more than the depreciated value than you are required to pay taxes, known as recapture taxes, that you haven't been paying as a result of the depreciation.
This is important to note because while you benefit from the depreciation deduction in the current year, you will face a gain on the deduction upon sale. This can be an important consideration if you plan to sell in the near future.
It is important for you to know that you can not avoid paying depreciation recapture taxes simply by converting the property to your principal residence. You will still owe these taxes when you sell the property. The only possible option is to delay the depreciation recapture taxes on a sale by taking the proceeds to invest in another property by using a 1031 Exchange.
If you have any further questions or concerns regarding depreciating your Airbnb property, please feel free to contact us.