Accelerated Depreciation
The accelerated depreciation definition is a type of depreciation that makes it possible for a homeowner or real estate investor to depreciate their property faster than the straight-line depreciation allows in the early years of the property. In other words, the accelerated depreciation is a way to enable a much bigger depreciation rate in the first few years of ownership while also decreasing the depreciation rates for the later years of the possession’s life.
Accelerated depreciation in real estate
Depreciation or straight-line depreciation is the typical depreciation that every asset goes through. As the years’ pass, the asset is affected by wear and tear, and its initial value diminishes. This declining value that affects the asset every year is known as depreciation. In real estate, properties are also affected by depreciation, and businesses are allowed by the IRS to depreciate their assets (residential or commercial properties) during their useful lives. This depreciation helps businesses to gain tax savings that can then be invested back into the business. However, time limits this depreciation as commercial and residential properties are allowed by the IRS to depreciate over 27.5 or 39 years. That is where accelerated depreciation comes in and provides for faster depreciation.
How does Accelerated Depreciation Work?
Since President Ronald Regan signed the Economic Recovery Tax Act of 1981 with its accelerated cost recovery system (ACRS), which was replaced with the modified accelerated cost recovery system (MACRS) in 1986, accelerated depreciation was possible.
This legal accounting practice allows the faster depreciation of a property during a much shorter period of time and is sanctioned by the IRS through MACRS. Property owners that want an accelerated depreciation on their property will need a cost segregation study. For example, some land improvements can be depreciated through MACRS for 15 years with a declining balance of 150%. Owners can depreciate personal property for 5 or 7 years with a declining balance of 200%.
The reasoning behind accelerated depreciation is that an asset, not particularly properties, is more heavily used during the first years of its life when it is new and functional. This is why that use at the beginning of the asset’s life should match the asset’s depreciation.
For example: To simplify the situation, we’ll look at something simple like a pair of headphones. When they are brand-new, the owner uses them all the time, but as months and years go by, the headphones age, new and better models are available on the market, and the initial pair of headphones is set to the side and used less often. As the asset ages, its importance lessens, but when it was new, it was continuously used.
Advantages and Disadvantages of Accelerated Depreciation
The most significant advantage of accelerated depreciation is reducing a company’s tax liability and its taxable income. This benefit allows companies to have more cash flow to invest back into the company and their products through marketing strategies that can increase their revenue.
The major disadvantage of accelerated depreciation is that it requires a cost segregation study, which costs money. In case a rental property investor is just starting their rental business, their revenues might be limited, and investing in a cost segregation study might not be the best investment. The tax situation of a business might not require an accelerated depreciation as not every business can benefit from it.
Popular Real Estate Terms
Type of investment company that invests money in mortgages and various types of investment in real estate, in order to earn profits for shareholders. Shareholders receive income from the ...
Frame surrounding a door or window to block adverse weather. It may be made of wood, metal, or other material. The frame may be fixed or moveable. ...
Same as term Veterans Administration Mortgage: Mortgage guaranteed up to 30 years by the Veterans Administration to veterans meeting minimum requirements. Originally established by the ...
Within Real Estate, “nuisance” is a term used to describe any disturbance that might affect neighboring houses. Nuisance abatement is the enforcing of policies and codes that ...
Calculator having various financial functions including present value, purchase price, property appreciation, lease costs, loan and mortgage amortization. ...
A lease requiring tenants to pay all utilities, insurance, taxes, and maintenance costs. ...
Any structure projecting from a wall or other vertical element for the purpose of providing support for a weight or other object. ...
Bankruptcy declared by any insolvent person or business. In contrast to involuntary bankruptcy, which is applied for by the creditors. ...
Residing in a structure that the individual owns. ...
Have a question or comment?
We're here to help.