depreciation.

Nothing is certain except death and taxes. Which one is preferable is debatable.

I rented out my condo in Cambridge last year. So far, being a landlord has been fine; I’ve got great tenants, and it’s been a bare minimum of hassle dealing with the lease and the records and what little maintenance is associated with a recently renovated apartment.

However, April 15^th is looming, and I’ve spent most of my free time over the last couple of months figuring out how to handle the taxes associated with rental property. In my naivety, I assumed the formula for computing the taxes would be pretty straightforward, and would go something like this:

1. Compute income from rent collected;
2. Compute expenses from mortgage payments, condo fees, maintenance, etc.;
3. Subtract b from a;
4. Add c to my gross income and pay taxes based on the adjusted figure.

Seems simple, right? Not so fast, amigo.

Enter the concept of depreciation, as applied to property. The IRS allows you (forces you, in fact) to count as an expense the reduction in value of the property due to aging and use over a certain period of time. In the case of the property, the period is twenty seven and a half (?!) years. When you convert it to a rental property, you have to declare the value as of the date of conversion, and they divide that number by twenty seven and a half years to find the amount you count as a depreciation expense when figuring the profit or loss for the property each year. On the one hand, it’s not so bad, because the depreciation helps reduce your net profit, and therefore minimizes the taxes. It can also drive you into net loss territory, although there are limits to what you claim because this is considered a “passive” loss. (There are more details here, but they are disappearing in a fog of ambivalence now that all my forms are filed.)

However, there’s a catch. If I understand this right, when you go to sell the property, the taxes you owe will be computed on the difference between the selling price and the depreciated value, not on what you actually paid for the place. Hypothetically, if you kept a place until it depreciated to zero (i.e., the aforementioned mysterious twenty seven and a half years), you’d owe taxes on the whole damn selling price. More realistically, if you sold near term for less than you paid at the height of the bubble back in 2005 (dammit), you could easily still owe taxes on the sale even though you lost money on the deal. This is commonly known as adding insult to injury.

All I know is that the taxes are so complicated that it’s basically impossible to make major financial decisions with any confidence. Should I sell the condo now or rent it out for another few years hoping that the market will recover? Even if I make specific assumptions about future property values (which is already tenuous enough), the tax computations are sufficiently complicated that I can’t say one way or the other which choice makes more sense. In the end, it’s the equivalent of throwing darts with your eyes closed.

As I’ve said before, I think one of the most patriotic things a person can do is pay their taxes without bitching about it. I honestly don’t have a problem with paying taxes; I make a good living, and I’m glad to pitch in my share. However, I do wish that it weren’t so complicated. I could take everything to an accountant to save some time, but I want to understand the rules, and I don’t think the rules should be so complicated that only someone with a degree in accounting can figure them out. It’s not like I’m running an international conglomerate; I’m just a guy renting out an apartment to cover the mortgage.

Damn, I miss the days of being able to use the 1040EZ.

screeds & diatribes

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