The Colorado Court of Appeals recently issued a decision of first impression in Colorado – whether straight-line depreciation could be deducted from a party’s rental income for purposes of child support or spousal maintenance. After all, a property owner does not actually write a check for depreciation from the rental income, and, realistically, real estate tends to increase in value rather than depreciate. So depreciation always seemed a bit of a fictitious expense, not an actual expense the court should deduct from a spouse or parent’s income.
Accelerated Depreciation Not Deductible from Rental Income
Colorado law already addresses depreciation. The child support statute provides that “ordinary and necessary expenses” shall be deducted from business or rental income. However, the law only explicitly disallows accelerated depreciation, by which the full value of certain assets may be deducted as an expense rather than amortizing the depreciation over a period of years:
“‘Ordinary and necessary expenses’ does not include amounts allowable by the internal revenue service for the accelerated component of depreciation expenses or investment tax credits or any other business expenses determined by the court to be inappropriate for determining gross income for purposes of calculating child support.C.R.S. 14-10-115(5)(a)(III)(B).
See also identical language in the maintenance statute, C.R.S. 14-10-114(8)(c)(III)(B).
Simplistically, straight-line depreciation means that as a business asset declines in value over time, it is depreciated over that same timeframe, whereas with accelerated depreciation, it is deducted faster than the decline. For more information on the differences, see IRS Publication 946.
Trial Court Deducted Depreciation from Rental Income
For purposes of maintenance, the trial court in Schaefer calculated the husband’s gross monthly income to be $57,662. The wife appealed, alleging that the court incorrectly allowed straight line depreciation to be deducted from the husband’s rental income. (She also appealed the calculation of her own income, and in a different blog post we addressed the Court of Appeals’ holding that unrealized gains in an investment account should not have been included in her income).
Court of Appeals – No Prohibition Against Deducting Depreciation
The appellate court rejected the wife’s position that the court should not consider any depreciation, thereby declining to hold that the child support and alimony statutes excluded all depreciation from business expenses. Schaefer, ¶ 1.
The court noted that while the statutory provision quoted above excludes from business expenses only “accelerated depreciation”, it was silent on whether all depreciation expenses should be excluded from deductible business expenses. And the two types of depreciation are not the same – the dictionary definition of depreciation is the “loss of value”, while accelerated depreciation means “depreciation of assets at a higher rate than that normally assigned to cover use and exhaustion.” ¶ 31
But the fact that the legislature chose to only exclude accelerated depreciation was instructive, and it was not inclined to go beyond the statute:
“If the legislature had intended to exclude all depreciation expenses from this calculation, it could have said so. We are not at liberty to read different terms into the plain language of these statutes.”Schaefer, ¶ 32 (emphasis in original).
Trial Court Must Make Findings Regarding Depreciation
However, there is similarly no automatic rule that all straight line depreciation should be deductible as a business expense – and instead, the trial court should have made more specific findings:
“Because the district court made no findings explaining why it considered all depreciation on the rentals to be an ordinary and necessary expense, we reverse the calculation of husband’s income. On remand, the court shall make factual findings concerning the type of the depreciation associated with husband’s rentals (i.e., whether the depreciation is accelerated) before it concludes whether the depreciation is an ordinary and necessary expense. As per Eaton, the court may not include in husband’s rental income calculation the depreciation that exceeds the rental income received.”Schaefer, ¶ 34.
Conclusion – Straight Line Depreciation Likely Deductible from Rent Income
While having the court of appeals reverse the trial court ruling may appear to be a victory for the wife, it likely is a pretty limited procedural victory, and appears intended to ensure that (1) the depreciation was all straight-line, not accelerated, and (2) none of the depreciation allowed on a specific property exceeded the rental income for that property.
Assuming the trial court explicitly finds these two conditions are satisfied, then the straight-line depreciation will be an allowable deduction from the rental income.
For more information on how rental income is included in child support and maintenance calculations, see our rental income article in the Colorado Family Law Guide.
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