For tax purposes, how is depreciation on an investment property determined?

Depreciation on an investment property is determined by taking the original purchase price and adding any capital improvements made to the property, while subtracting the land value. This approach reflects the concept that land does not depreciate while the building and improvements do. The rationale behind this method is that only the depreciable portion of the investment—which includes the building and any enhancements—can be accounted for to reduce taxable income over time.

When considering depreciation for tax purposes, adjusting for the value of the land is crucial because only the structures and improvements will see a reduction in value over their useful life. This adjustment ensures that financial reporting and tax filings accurately reflect the ongoing investment in the property while recognizing that land typically retains its value.

In contrast, focusing solely on the original purchase price disregards any enhancements that could increase the property’s value and fails to account for the land’s separate status. Considering only capital improvements neglects the initial investment in the property and can lead to inaccuracies in depreciation calculations. Lastly, using market value minus improvements is not standard practice for determining depreciable basis, as it can lead to fluctuations based on changing market conditions rather than a stable investment assumption.

Thus, the correct approach of using the purchase price, adding capital improvements, and subtracting