The warmer the weather, the more likely an air conditioner will need to be replaced, or so it seems. If you use that air conditioning unit in a rental property, you may be wondering how to report the cost for income tax purposes. With the right information, you will be able to claim depreciation.
An air conditioner can be an expensive purchase for your rental unit. As a cost-savvy landlord, you will want to use the cost of the AC unit to offset your rental income at tax time. The Internal Revenue Service expects that an air conditioner will have a useful life of more than one year. They require that you claim a portion of the cost of the air conditioning unit in your tax filings for each year of its useful life. To do this, you will need certain pieces of information.
What Is Depreciation?
Depreciation is a method of allocating the expense of a piece of equipment over the number of years it is expected to be useful. It gives a clearer picture of your business's performance. If you were to include the entire cost of the equipment in one year, you would have a large expense the year you purchased the equipment, and then no such expense in subsequent years, even though that equipment is still being used to generate income. Depreciation breaks up the cost to better tie expenses and income together in a given reporting period.
How Do I Record Depreciation?
Generally accepted accounting principles (GAAP) allow for recording depreciation using three methods: straight-line depreciation, units of production/output, or one of two accelerated methods. In any of these GAAP methods, you need to know the cost of the asset and its expected salvage or scrap value. The difference between these two numbers is called the depreciable base, which is the figure you will use when calculating your depreciation expense each accounting period. You will also need to know the asset's expected useful life, whether stated in years, hours of use, units of production or another method. The journal entry will debit Depreciation Expense and credit Accumulated Depreciation, a contra-account that reduces the value of the Property, Plant, and Equipment account.
How Do I Report Tax Depreciation of an Air Conditioning Unit?
Depreciation is reported on IRS Form 4562. The IRS determines the useful lives of different types of assets. This is called the asset's class life. The recovery period on Form 4562 comes from this determination. When it comes to appliances used in rental property, including air conditioning units, the recovery period is 5 years. For tax purposes, you will need to know which convention you can use to state the date the asset was placed in service.
You will use the mid-quarter convention if you purchased more than 40 percent of the assets in the final quarter of the year, or the half-year convention if not. Mid-quarter means that you will treat the asset as though you placed it into service at the midpoint of the quarter in which you purchased it. Half-year means that you will treat the asset as placed in service at the midpoint of the year.
The last piece of information you need to know to calculate depreciation on a piece of equipment is the depreciation method. Per IRS Publication 527, air conditioner depreciation, along with any other 5-year class life property, will be calculated using the 200 percent declining balance method. The percentage of the depreciable basis that you report as an expense each year or each quarter depends on the convention you must use. The best way to calculate this accurately is to refer to the MACRS GDS Percentage Tables in IRS Publication 527. You will multiply the given percentage for that period by the total depreciable base for that asset.