Real Estate Depreciation: Complete Tax Guide for Property Investors

Real estate depreciation is one of the most powerful tax benefits available to property investors. It allows you to deduct a portion of your property's cost each year—reducing your taxable income—even though the property may actually be increasing in value.

Many new investors don't fully understand depreciation or fail to maximize its benefits. This guide explains exactly how depreciation works, how to calculate it, and how to use advanced strategies to accelerate your deductions.

What Is Real Estate Depreciation?

Depreciation is an accounting method that spreads the cost of an asset over its useful life. The IRS recognizes that rental properties wear out over time due to deterioration and obsolescence, so they allow you to deduct a portion of the property's value each year.

Here's the key concept: Even if your property appreciates in market value, the IRS assumes the building itself is wearing out. You get to deduct this theoretical wear-and-tear from your taxable income.

Why Depreciation Is Powerful

Depreciation is a non-cash deduction. You don't have to spend any money to claim it—yet it reduces your taxable income just like cash expenses do.

Example: You own a rental property that generates $20,000 in annual rental income. After deducting $12,000 in cash expenses (mortgage interest, insurance, repairs, etc.), you have $8,000 in profit. You also claim $7,000 in depreciation. Your taxable rental income is now only $1,000—even though you actually pocketed $8,000 in cash.

Over the life of your investment, depreciation can save you tens or even hundreds of thousands of dollars in taxes.

The Basic Depreciation Rules

Only the Building Depreciates, Not the Land

You can only depreciate the building and improvements—not the land underneath. Land doesn't wear out, so the IRS doesn't allow depreciation on it.

You must allocate your purchase price between:

Land (not depreciable)
Building and improvements (depreciable)

Residential vs. Commercial Property Depreciation Period

The IRS assigns different "useful lives" depending on property type:

Residential rental property: 27.5 years

Single-family homes
Duplexes, triplexes, fourplexes
Apartment buildings
Condos and townhouses

Commercial property: 39 years

Office buildings
Retail spaces
Warehouses
Mixed-use buildings (where less than 80% is residential)

The calculation: Divide the depreciable basis by the recovery period.

Residential: Building value ÷ 27.5 years = annual depreciation
Commercial: Building value ÷ 39 years = annual depreciation

When Depreciation Starts

You begin depreciating property when it's "placed in service"—the date it's ready and available for rental, even if you don't have a tenant yet.

Example: You close on a property June 15 and spend two weeks cleaning and making repairs. You list it for rent July 1. Depreciation starts July 1.

When Depreciation Stops

Stop depreciating when:

You sell the property
You've fully depreciated the basis
You convert it to personal use
It's no longer used in a trade or business

How to Calculate Depreciation: Step by Step

Step 1: Determine Your Property's Cost Basis

Your basis is the total amount you can depreciate. It includes:

Purchase price components:

Purchase price paid to the seller
Closing costs (title insurance, recording fees, legal fees)
Inspection and appraisal fees
Survey costs
Any assumption of seller's liabilities

NOT included in basis:

Loan origination fees and points (deduct separately over loan life)
Insurance premiums (deduct in the year paid)
Real estate commissions (generally yes, but consult your tax advisor)

Example:

Purchase price: $300,000
Closing costs: $8,000
Total basis: $308,000

Step 2: Allocate Between Land and Building

You need to separate land value from building value. The IRS accepts several methods:

Method 1: Use the property tax assessment Most reliable and audit-proof. Your county tax assessor assigns separate values to land and improvements.

Example:

Total basis: $308,000
Tax assessment shows 20% land, 80% building
Land basis: $308,000 × 20% = $61,600 (not depreciable)
Building basis: $308,000 × 80% = $246,400 (depreciable)

Method 2: Professional appraisal Hire an appraiser to allocate value between land and building. More expensive but defensible.

Method 3: Comparable sales Analyze recent sales of land-only lots in the area to estimate land value.

For most investors, the tax assessment method is simplest and IRS-approved.

Step 3: Calculate Annual Depreciation

For residential rental property:

Annual depreciation = Building basis ÷ 27.5 years

Using our example:

Building basis: $246,400
Annual depreciation: $246,400 ÷ 27.5 = $8,960/year

Step 4: Adjust for First-Year Convention

In the first year, you use the mid-month convention—you only get depreciation for the months the property was in service.

Example: Property placed in service July 1 (mid-year)

Full annual depreciation: $8,960
Months in service: 6 months (July-December)
First-year depreciation: $8,960 × 6/12 = $4,480

In subsequent years, you claim the full $8,960.

The mid-month convention also applies in the year you sell the property.

MACRS: The Method You'll Use

The IRS requires real estate investors to use the Modified Accelerated Cost Recovery System (MACRS) with the straight-line method for rental property.

Straight-line depreciation means you deduct the same amount each year (except the first and last years).

Why "accelerated" if it's straight-line? You can accelerate depreciation on specific components using cost segregation (covered below).

Additional Improvements and Capital Expenditures

When you make improvements to rental property, you typically must depreciate them rather than deduct them immediately.

Repairs vs. Improvements

Repairs (immediately deductible):

Fixes that keep the property in working order
Painting
Fixing a leak
Replacing broken windows
Patching a roof

Improvements (must depreciate):

Betterments that add value
New roof
Addition or expansion
New HVAC system
Kitchen remodel
New appliances

Gray area: Replacing several components during a [renovation](/blog/bathroom-renovation-cost-guide) may require capitalization and depreciation even if individual items would normally be repairs. The IRS "unit of property" rules are complex—consult a tax professional.

Depreciation Periods for Improvements

Different improvements have different recovery periods:

5 years: Appliances, carpet, furniture
7 years: Office furniture, some equipment
15 years: Land improvements (parking lots, fences, landscaping)
27.5 years: Structural improvements to residential property
39 years: Structural improvements to commercial property

Accelerating depreciation: By properly classifying improvement components, you can depreciate them faster than 27.5 years (this is where cost segregation comes in).

[Bonus Depreciation](/blog/depreciation-rental-property-guide) and Section 179

Bonus Depreciation

Bonus depreciation allows you to deduct a large percentage of the cost of certain property in the first year.

Current rules (as of 2026):

The Tax Cuts and Jobs Act allowed 100% bonus depreciation through 2022
Currently phasing down: 60% in 2024, 40% in 2025, 20% in 2026
Scheduled to expire after 2026 (though Congress may extend)

What qualifies:

Property with a recovery period of 20 years or less
Personal property (appliances, carpet, furniture)
Components identified through cost segregation

What doesn't qualify:

Buildings and structural components
Land and land improvements

Section 179

Section 179 allows immediate expensing of certain business property, up to annual limits ($1.16 million limit in 2023, with a phase-out threshold of $2.89 million).

For rental property:

Generally not available for residential rental real estate
May be available for commercial property and personal property used in rental operations
Requires active participation in the rental activity

Most residential landlords won't use Section 179—bonus depreciation is more applicable.

Cost Segregation: Accelerate Your Depreciation

Cost segregation is an advanced strategy that can dramatically accelerate depreciation deductions in the early years of property ownership.

How Cost Segregation Works

Rather than depreciating the entire building over 27.5 years, a cost segregation study identifies components that can be depreciated over 5, 7, or 15 years:

5-year property:

Carpet and vinyl flooring
Appliances
Some window treatments

7-year property:

Office furniture and fixtures
Some specialty equipment

15-year property:

Landscaping
Sidewalks and parking lots
Fences

27.5-year property:

Building structure
Roof (generally)
Plumbing and electrical systems (built-in)

Example without cost segregation: $500,000 rental property

Land: $100,000 (not depreciable)
Building: $400,000 ÷ 27.5 = $14,545/year

Example with cost segregation: Same property, but the study reclassifies:

$50,000 as 5-year property
$30,000 as 15-year property
$320,000 remains 27.5-year property

First-year depreciation:

5-year property: $50,000 (with bonus depreciation)
15-year property: $2,000
27.5-year property: $11,636
Total first year: $63,636 (vs. $14,545 without cost segregation)

When Cost Segregation Makes Sense

Cost segregation studies cost $5,000-$15,000+ depending on property complexity. It's most beneficial for:

✓ Properties worth $500,000+ ✓ Recently purchased properties (within current tax year) ✓ Properties with significant personal property or land improvements ✓ Investors with high taxable income from other sources ✓ Properties that underwent major renovations

Not worth it for:

Properties under $300,000
Properties owned for many years (less depreciation remaining)
Investors with little taxable income to offset

Passive Activity Loss Rules May Limit Benefits

Even with accelerated depreciation, you may not be able to deduct all losses immediately if you're a passive investor (covered in the next section).

Passive Activity Loss (PAL) Rules

The IRS limits your ability to deduct rental losses against other income (like W-2 wages) through Passive Activity Loss rules.

Passive vs. Active Participation

Passive investor:

[Property management](/blog/property-management-complete-guide) company handles everything
You make minimal decisions
Losses can only offset passive income (other rental income, partnership distributions)

Active participant:

You make management decisions (approve tenants, set rent, approve repairs)
May qualify for $25,000 special allowance

Real estate professional:

Spends 750+ hours/year in real estate activities
Real estate is primary occupation
Can fully deduct rental losses against any income

The $25,000 Special Allowance

If you actively participate in your rental property, you can deduct up to $25,000 in rental losses against your ordinary income (W-2 wages, business income, etc.).

Requirements:

You own at least 10% of the property
You actively participate (make management decisions)
Your modified adjusted gross income (MAGI) is under $100,000

Phase-out: The $25,000 allowance phases out by 50 cents for every dollar of MAGI above $100,000.

MAGI of $150,000+: No allowance available

Example: You have $80,000 in W-2 income and $30,000 in rental losses (including depreciation). You actively participate.

You can deduct $25,000 of rental losses against W-2 income
Remaining $5,000 carries forward to future years

Suspended Losses

Losses you can't deduct due to PAL rules are "suspended" and carried forward indefinitely. You can use them when:

You have passive income in future years
You qualify as a real estate professional
You sell the property (all suspended losses become deductible)

Depreciation Recapture: What Happens When You Sell

Depreciation isn't free money—the IRS requires you to "recapture" it when you sell the property.

How Recapture Works

Depreciation recapture means you pay tax on the depreciation you've claimed over the years.

Tax rate: 25% federal rate on recaptured depreciation (not your ordinary income rate)

Example: You bought a rental for $300,000 (building basis $240,000). Over 10 years, you claimed $87,273 in depreciation. You sell for $400,000.

Without depreciation recapture calculation:

Sale price: $400,000
Adjusted basis: $300,000 - $87,273 = $212,727
Total gain: $400,000 - $212,727 = $187,273

The gain is split:

Depreciation recapture: $87,273 × 25% = $21,818 tax
Capital gain: $100,000 × 15-20% (depending on income) = $15,000-$20,000 tax

Total tax: ~$36,818-$41,818

You Must Recapture Even If You Didn't Claim Depreciation

Here's a critical rule: The IRS requires recapture on depreciation you were "allowed or allowable"—even if you forgot to claim it.

Example: You owned a rental for 10 years but never claimed depreciation (leaving thousands in tax savings on the table). When you sell, you still owe recapture tax on the depreciation you should have claimed.

Lesson: Always claim depreciation. You're going to pay tax on it when you sell anyway.

Avoiding Recapture with a [1031 Exchange](/blog/1031-exchange-guide)

A 1031 [like-kind exchange](/blog/1031-exchange-for-beginners) allows you to defer depreciation recapture and capital gains by rolling your proceeds into a new investment property.

Requirements:

Exchange must be completed within strict timelines (45 days to identify, 180 days to close)
Must use a [qualified intermediary](/blog/1031-exchange-rules-2026)
New property must be equal or greater value
Must reinvest all proceeds

Benefit: Depreciation recapture and capital gains are deferred indefinitely (you can keep exchanging properties until death).

Maximizing Your Depreciation Deductions

1. Always Claim Depreciation

Never skip depreciation thinking you'll avoid recapture. You'll pay recapture tax anyway—might as well get the benefit.

2. Keep Detailed Records

Document:

Purchase closing statement
Property tax assessments
Improvement invoices and receipts
Cost segregation study (if done)

3. Track Capital Improvements Separately

Maintain a log of improvements with:

Date placed in service
Cost
Depreciation period (5, 7, 15, or 27.5 years)

4. Consider Cost Segregation for Large Properties

For properties over $500,000, a cost segregation study can front-load deductions and improve cash flow.

5. Understand Your State's Depreciation Rules

Some states don't conform to federal depreciation rules or bonus depreciation. You may need to add back deductions on your state return.

6. Hire a Real Estate-Focused CPA

Generic tax preparers often miss depreciation opportunities. A CPA experienced with rental property can:

Maximize component depreciation
Ensure proper classification of repairs vs. improvements
Plan for depreciation recapture
Structure 1031 exchanges

The fee pays for itself in tax savings.

Special Situations

Short-Term Rentals

If your rental qualifies as a "business" rather than passive rental (providing substantial services like a hotel), different rules apply:

May qualify for Section 199A qualified business income deduction
May allow non-passive treatment of losses
May qualify for immediate expensing of certain improvements

Requires significant involvement and substantial services.

Converting Personal Residence to Rental

When you convert your personal home to a rental:

Basis is the lower of original cost basis or fair market value on conversion date
Start depreciating from the conversion date
Keep records documenting the conversion

Partial Rental Use

If you rent part of your home (like a basement apartment):

Depreciate only the percentage used for rental
Allocate expenses proportionally
Home office rules may apply

Common Depreciation Mistakes

1. Not Depreciating the Property

Huge missed opportunity—claim every deduction you're entitled to.

2. Depreciating Land

Only the building depreciates. Always separate land and building value.

3. Immediately Deducting Capital Improvements

New roofs, HVAC systems, and major renovations must be depreciated, not immediately expensed.

4. Forgetting to Depreciate Personal Property

Appliances, carpet, and furniture have shorter lives (5-7 years) and can be depreciated faster.

5. Not Adjusting Basis When You Sell

Your basis decreases by depreciation claimed. Forgetting this results in overpaying capital gains tax.

6. Using TurboTax for Complex Situations

DIY tax software works for simple scenarios but often misses optimization opportunities for rental property. A [real estate CPA](/blog/how-to-build-real-estate-team) is worth the investment.

Final Thoughts

Real estate depreciation is one of the most valuable tax benefits for property investors. By reducing your taxable income with a non-cash deduction, you keep more of your rental income while building wealth through [property appreciation](/blog/best-cities-for-appreciation-2026).

Key takeaways:

Residential property depreciates over 27.5 years; commercial over 39 years
Only the building depreciates—land does not
Cost segregation can accelerate depreciation for valuable properties
Passive activity loss rules may limit current deductions
Depreciation recapture applies when you sell (but can be deferred via 1031 exchange)
Always claim depreciation—you'll pay recapture tax whether you claimed it or not

Work with a qualified tax professional to ensure you're maximizing depreciation deductions while staying compliant with IRS rules. The tax savings over the life of your investment can be substantial—often tens of thousands of dollars or more.

Depreciation isn't just a tax strategy—it's a fundamental reason why real estate is one of the most tax-advantaged investments available.

Depreciation Real Estate Guide

Key Takeaways