How to Calculate Vacation Rental Property Depreciation: A Guide for Brokers

Are you a residential or commercial mortgage broker, private lender, or referral partner working with clients looking to invest in vacation rental properties? In that case, understanding how to calculate depreciation can be a valuable tool. Depreciation can significantly affect your client's tax strategy and overall investment returns. By educating yourself on this topic, you can better serve your clients and position yourself as a trusted advisor in their investment journey.

In this blog, we’ll break down how depreciation works on short-term rental property, the factors that influence it, and how you, as a broker or wholesale partner, can help your clients make informed decisions.

What Is Rental Property Depreciation?

Depreciation is the process of deducting the value of a rental property and the assets on it over their usable lifespan. Rather than taking one large deduction in the year you buy (or improve) the property, depreciation distributes the deduction across the useful life (27.5 years) of the property. The amount you can deduct will depend on a few things, such as your basis in the property, the recovery period, and the depreciation method that is used.

For third-party originators, knowing the details of depreciation can help you answer client questions and showcase your expertise. Your clients may ask, “How do I calculate depreciation on rental property?” or, “Is depreciation different for short-term rental property?” By having a solid understanding of the rules, you can confidently guide them through these concerns and demonstrate the value you bring as their broker or partner.

Depreciation Requirements for Vacation Rental Properties

The Internal Revenue Service (IRS) has specific rules when it comes to depreciation that rental property owners should be aware of. In order to depreciate a rental property, the following requirements must be met:

1. The property is owned by the client: Only properties owned outright by the client are eligible for depreciation.
2. The property is used to generate income: If the property is used for personal vacations more than it’s rented out, it will not qualify.
3. The property has a determinable useful life: This means the property will naturally lose value over time.
4. The property’s life expectancy exceeds one year: Short-term repairs or improvements aren’t eligible for depreciation.

For brokers and wholesale partners, this knowledge can help you explain to clients why some of their properties or expenses may not be depreciable and guide them toward investments that maximize tax benefits.

How Do You Determine Depreciation on a Rental Property?

To calculate depreciation, your clients need to consider three key factors:

1. The property’s basis: This is the amount paid to acquire the property, including certain associated costs.
2. The recovery period: For residential rental properties, this is 27.5 years.
3. The depreciation method: Most properties are depreciated using the Modified Accelerated Cost Recovery System (MACRS).

As a broker or wholesale partner, you can add value by providing resources or recommending tax professionals who specialize in helping clients calculate their depreciation.

Step-by-Step Guide to Calculating Depreciation

Step 1: Determine the Basis of the Property
The property’s basis includes the purchase price and other allowable costs such as:

• Sales tax paid at purchase (unless you deducted state and local general sales tax on the Schedule A/Form 1040 as an itemized deduction)
• Settlement costs (e.g., legal fees, title insurance, and back taxes)
• Installation or testing charges

Some settlement fees that can’t be included in your client basis include fire insurance premiums, rent for tenancy of the property before closing, or any charges related to getting or refinancing a loan such as mortgage insurance premiums, credit report cost, or appraisal fees.

Step 2: Separate Land Value from Building Value
Since depreciation only applies to the building (not the land), your clients need to allocate the purchase price between the two. For example, if a property is purchased for $110,000 and is valued at $90,000 ($81,000 for the building and $9,000 for the land), 90% of the purchase price can be allocated to the building.

Step 3: Calculate the Depreciable Basis

As we mentioned above, the basis of the property is the amount you paid. Using the above example, we can determine the basis of the rental by calculating 90% of $110,000. So, the basis of the property (the amount that can be depreciated) would be $99,000.

If you wanted to calculate the amount that can be depreciated each year, you’d take the basis and divide it by the 27.5-year recovery period: $99,000 / 27.5 = $3,600 per year.

Why Depreciation Matters for Your Clients

Depreciation offers your clients several benefits:

• Tax Savings: Depreciation allows property owners to distribute their costs over time thus decreasing their taxable income.
• Improved Cash Flow: When your clients face reduced tax responsibilities they get better cash flow which enables them to reinvest or pay for other costs.
• Long-Term Strategy: Property depreciation serves investors who want to optimize their returns because it matches their long-term ownership approach.

Your clients will experience better investment outcomes when you teach them about these advantages which will simultaneously build trust between you as well.

How Brokers Can Use Depreciation as a Selling Point

1. Build Trust and Credibility
   Clients value brokers who provide additional value beyond basic deal completion services. By proactively addressing topics like depreciation, you position yourself as an invaluable resource for their financial success.
2. Recommend Expert Partners
   Your clients will appreciate your recommendation of trusted tax advisors or accountants, although you don't need to be an expert yourself. When clients interact with you they recognize your dedication to their ongoing business success by referring them to these professionals.
3. Emphasize the Bigger Picture
   Depreciation serves as just one element of many in the investment picture. Your understanding of real estate investing emerges when you put depreciation within the broader framework of property performance and tax optimization.

Additional Tips for Brokers Working with Vacation Rental Investors

• Highlight Depreciation Benefits Early: Let clients know from your first meeting that depreciation creates positive effects on their investment returns.
• Provide Tools and Resources: Share easy-to-use calculators or guides that help clients estimate their depreciation.
• Stay Informed: Tax laws as well as local regulations experience periodic changes. Your clients benefit from your accurate guidance because you maintain current knowledge.

The Bottom Line

Depreciation is a valuable tool for rental property owners as it allows your clients to spread the cost of buying over time and reduces their yearly tax bill. While this hopefully gives you a better understanding of depreciation, it’s always recommended to refer clients to a professional tax advisor when determining tax deductions for rental properties.

Looking to Finance the Next Vacation Rental Property?

Here at RCN Capital, we can help you provide financing options for your clients’ vacation rental property needs. We also offer financing programs for long-term rental property investments. If your clients are looking to invest in property to generate rental income, RCN has you covered. Reach out today to learn more about our loan programs.