Allowed Versus Allowable Depreciation

By Jason Watson, CPA
Posted Monday, August 5 2024

The question comes up often where a real estate investor does not want to mess with rental property depreciation for whatever reason and decides against deducting it on their tax returns. The most common reasoning is- why depreciate my rental property since I cannot deduct the rental loss on my tax returns?

This will bite you because according to IRS Publication 544 Sales and Other Dispositions of Assets–

The greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) is generally the amount to use in figuring the part of the gain to be reported as ordinary income. If you can show that the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation.

What does this mean? Generally, if you don’t deduct rental property depreciation, when you sell the property, you will be required to recapture depreciation as if you deducted it. Yuck. However, if you didn’t deduct rental depreciation on prior tax returns, you can easily fix it with a Form 3115 Application for Change in Accounting Method and Section 481(a) adjustment.

Allowed is what you claimed and deducted. Allowable is what you should have claimed and deducted. Keep in mind that just because depreciation deduction does not immediately help you because of passive loss limitations, you will benefit when either a) you sell property or b) have rental income (profits) in the future. As such, you should always (which is a big word) depreciate your rental property. We have a section on selling your rental property on page xx.

In related news, Canada allows rental property owners to opt out of depreciation entirely. Who knew? Makes sense when most real estate appreciates and doesn’t depreciate, right? Here is another gee whiz consideration- Canada calls it Capital Cost Allowance (CCA).