3

I converted my primary residence into a rental property last year. For depreciation purposes, I must choose between GDS ("General Depreciation System") or ADS ("Alternative Depreciation System"). Once I choose, I can never change it.

The primary difference seems to be that ADS gives you a 40-year depreciation duration, whereas the GDS is 27.5 years for residential rental property.

I'm new to the concept of depreciation. My basic understanding is that with a longer depreciation period you get a smaller (passive) deduction each year. But, your cost basis doesn't decrease as quickly. So, if I'm going to sell the property in 10 years, I'll have less capital gains due to the higher basis.

Currently, the property is giving me a small passive loss. But I have no passive income, so I can't use the deduction.

What else should I consider before making the choice? (e.g. inheritance issues, converting it back to a primary residence, etc?)

Thank you.

From IRS Pub 527 (2014):

If you choose to use ADS for your residential rental property, the
election must be made in the first year the property is placed in
service. Once you make this election, you can never revoke it. For
property placed in service during 2014, you make the election to use
ADS by entering the depreciation on Form 4562, Part III, Section C,
line 20c.
5

There are specific cases where you are required to use ADS:

Required use of ADS. You must use ADS for the following property.

  • Listed property used 50% or less in a qualified business use. See chapter 5 for information on listed property.

  • Any tangible property used predominantly outside the United States during the year.

  • Any tax-exempt use property.

  • Any tax-exempt bond-financed property.

  • All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.

  • Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts.

See publication 946. If none of those apply to your property - you may elect ADS. Why would you elect ADS when you're not required to use it? If you can't think of a reason, then don't elect it. For most people the shorter the depreciation period - the more they can deduct (or accumulate in passive losses) each year, and that is usually the desirable case.

If you plan on selling in 10 years, keep in mind the depreciation recapture and consider whether the passive losses (offsetting regular income) are worth the extra tax in this case.

  • Thank you, that is helpful. Would you be willing to expand on the "depreciation recapture" and "whether the passive losses are worth the extra tax"? I don't really understand how this all plays out in the future. – bitsmack Mar 4 '15 at 19:06
  • @bitsmack you may want to talk to a licensed tax adviser (EA/CPA licensed in your State). – littleadv Mar 4 '15 at 21:34
  • 1
    I just spent some time reading about depreciation recapture, and I agree that I should talk to a professional :) Thanks! – bitsmack Mar 5 '15 at 17:52
0

The 40 year option has been changed to 30, I believe. I'm researching that. But if depreciation has never been claimed and you need to "recapture" it anyway, then 40 years is definitely preferable.

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