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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.)