A precise understanding of the structure of"depreciation expense"and how to calculate it, which is required for tax filing when selling real estate, is essential knowledge for investors and owners. If the calculation is wrong, you may not only lose tax-saving opportunities but also face the risk of overreporting.
What is real estate depreciation expense?
Depreciation expense is the accounting treatment that allocates, over the useful life of an asset, the portion of fixed assets such as buildings and equipment whose value declines over time. Land is excluded because it is generally considered not to lose value, so in real estateonly the building portionis subject to depreciation.
There are three types of useful life for real estate
The following are the three main ways to think about useful life.
- Statutory useful life: the standard accounting life of a building set by the government. It is used most often for real estate valuation
- Physical useful life: the number of years until a building can no longer be used physically
- Economic useful life: the period during which the asset is judged to retain actual value, including repair costs and related factors
Why does useful life differ between business use and residential use?
Even for the same wooden building,the useful life is set at 22 years for business use (rental properties and stores) and 33 years for residential use (sale of an owner-occupied home). This is a policy design intended to reduce the tax burden when a private residence is sold.
How is depreciation expense calculated?
Depreciation expense = acquisition price × depreciation rate based on useful life
As a general rule, real estate acquired in or after April 2007 is subject to thestraight-line method.
Difference between the straight-line method and the declining-balance method
- Straight-line method: the same amount is depreciated each period. It is simple to calculate and tends to make profits easier to show in the early stage
- Declining-balance method: depreciation is calculated by applying a fixed rate to the undepreciated balance. The depreciation amount is larger at the beginning and gradually decreases
Calculation example (non-business-use wooden building)
If a non-business-use wooden property (useful life: 33 years; depreciation rate: 0.031) was purchased for 10 million yen and 15 years have elapsed:
10 million yen × 0.9 × 0.031 × 15 years = depreciation expense4,185,000 yen
Building acquisition cost = 10 million yen - 4,185,000 yen = 5,815,000 yen
Frequently asked questions (FAQ)
Q. Where can I find the acquisition price used to calculate depreciation expense?
A. Refer to the sales contract or the fixed asset tax assessed value. If the land and building were purchased together, the building price is calculated using the allocation ratio based on the fixed asset tax assessed value.
Q. How does depreciation expense affect the sale of a private residence?
A. When calculating the capital gain on sale, the building acquisition cost after subtracting depreciation expense from the "acquisition cost" is used. The lower the building acquisition cost, the larger the capital gain and the higher the income tax.
Q. What happens to the useful life of a secondhand property whose age exceeds the statutory useful life?
A. If the statutory useful life has been exceeded, the simplified method of "useful life × 20%" is used. For example, if a wooden building has a statutory useful life of 22 years, the applicable useful life is 4 years (22 × 0.2).
Q. Should depreciation expense calculations be handled by a professional?
A. The calculation method differs depending on the acquisition date, use, and structure, and some cases are complex. Consulting a tax accountant for a final return or tax filing at the time of sale can help prevent calculation mistakes and filing omissions.
