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Can You Depreciate Your Leased Property?

Leasing a property involves giving another party the right to use the leased property, usually in return for monetary compensation. Depreciation refers to the practice of claiming the costs related to the property as tax deductions over time. Depending on the arrangement, the lessor or the lessee may have the right to depreciate the leased property.

Ownership

    The party who depreciates the leased property has to have the "incidents of ownership," according to the Internal Revenue Service. This means that he must retain the legal title to the property and the obligation to pay various costs related to the property, including repairs, maintenance and operating costs. He must also pay any taxes on the property and bear the risk of a loss if the property loses value or becomes useless.

Lease Types

    Generally, there are two types of property lease: operating lease and capital lease. Operating lease allows the lessee to use the property for some time, but the lessee has to return the property to the lessor at the end of the lease. A capital lease, on the other hand, gives the lessee the right to buy the leased property below market price at the end of the lease. To qualify as a capital lease, the lease term has to run for at least 75 percent of the entire life of the leased property.

Depreciation

    Who gets to claim depreciation deductions on a leased property depends on the terms of the lease. With an operating lease, the lessor retains ownership to the leased property. As such, the lessor in an operating lease can depreciate the costs of the leased property. On the other hand, a capital lease is similar to a purchase with financing from the seller. As such, the lessee can claim the depreciation of a property in a capital lease.

Considerations

    The party that owns the leased property has the right to depreciate the cost of acquiring the property. In the case of an operating lease, the lessor depreciates the purchase price of the property. For a capital lease, the lessee depreciates the present value of the lease payments over the useful life of the leased property. If this value exceeds the fair value of the property at the beginning of the lease, the lessee can only depreciate the fair value of the property. Regardless of the lease type, the party who makes capital improvements on the leased property can depreciate the costs of such improvements.


  • Publication 946 (2012), How To Depreciate Property

    www.irs.gov/publications/p946/ch02.html

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