Welcome
to the Wiesenberg & Co. Certified Public Accountants foreign
property owner tax update.
How
can depreciation be used to help reduce or eliminate United States
taxes on rental income?
Expenses
can offset income as long as the villa is being treated as a business
(see our last bulletin). For this purpose deductions work the
same way they would for a domestic business, which include a wide
range of expenses. A significant but complicated item that can
be deducted is depreciation.
Depreciation
occurs when items are purchased which have a benefit that extends
for more than one year. In this situation, the entire expense
does not immediately lower income. The benefit of the expense
has to be taken over the life of the expense.
Unlike
many other countries, American-taxing authorities allow property
owners to depreciate the expense incurred when a building is purchased
or when major improvements are made. This is true even when the
value of a property actually appreciates.
Depreciable
items include everything from the villa itself (not the land)
to the cost of constructing a web-site (in the case of an intangible
asset like a web-site the term used is amortization). Each category
of items has different rates of depreciation. Most villas that
are rented out are depreciated over 27.5 years. The furniture
or other items inside are depreciated over seven, five, or three
years. Special options to accelerate the depreciation or expense
an item entirely also exist.
Much
care needs to be used when selecting these methods because many
of them can not be revoked. On the one hand, in order to minimize
taxes it is important to take the maximum possible depreciation
to reduce revenue. This often means using accelerated depreciation
methods as well as using the option to expense some items entirely.
On the other hand using these options must be done carefully to
avoid using depreciation up when in future years it could be used
more beneficially.
Reminder:
If you use a property manager, a key piece of information needed
to prepare your tax return is a 1099 form. Your property manager
must send this out by the end of February - so keep your eye out
for it.
Tax
tip of the day
Neglecting
to file annual tax returns in almost all cases results in significant
increase in taxes due when a property is sold.
Depreciation's
effect of lowering the value of the villa will cause the gain
to be greater (or loss to be smaller) when it is sold. This increases
the taxes due at the time of sale. This happens whether or not
the villa owner files annual mandatory tax returns for the property.
If no return is filed, not only are the annual tax advantages
of depreciation lost, but the IRS may raise an assessment and
arbitrarily decide on what your income and expenses were during
those years. This almost always results in more of a gain and
higher taxes when the property is sold.
Please
contact us with any comments or questions
you may have.
(This
newsletter is designed to be of general interest. The specific
techniques and information discussed may not apply to you. Before
acting on any matter contained herein, consult with your professional
advisor.)
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