Depreciation Strategy for DSCR Loan Properties

Depreciation Strategy for DSCR Loan Properties

Depreciation is the most powerful tax benefit of rental property ownership. It creates a deduction for the "wearing out" of your property — even though the property is likely appreciating in value. For DSCR loan investors, depreciation often turns taxable income into paper losses.

How Straight-Line Depreciation Works

The IRS requires residential rental property to be depreciated over 27.5 years using the straight-line method:

Annual Depreciation = (Purchase Price - Land Value) ÷ 27.5

Example:

• Purchase price: $300,000
• Land value: $60,000 (typically 15-25% of total value)
• Depreciable basis: $240,000
• Annual depreciation: $240,000 ÷ 27.5 = $8,727/year

This $8,727 deduction requires no cash outlay — it's a pure tax benefit.

Cost Segregation: Accelerated Depreciation

Cost segregation reclassifies components of your property into shorter depreciation periods:

The result: Instead of depreciating $240,000 evenly over 27.5 years ($8,727/year), you might depreciate $60,000 of that in the first 5-7 years — creating significantly larger deductions in the early years.

Example with cost segregation:

• 5-year property identified: $40,000
• 15-year property identified: $25,000
• 27.5-year property remaining: $175,000

Year 1 depreciation: ~$14,000 (vs. $8,727 without cost segregation)

Cost segregation studies typically cost $3,000-$7,000 and are worthwhile on properties valued at $300,000+.

Bonus Depreciation

Under current tax law, bonus depreciation allows you to deduct 40% (2026 rate — reduced from 100% in 2022) of the cost of qualifying assets in the first year. This applies to the 5-year and 15-year components identified in a cost segregation study.

Example with bonus depreciation (2026):

• 5-year property: $40,000 × 40% = $16,000 bonus + regular depreciation
• 15-year property: $25,000 × 40% = $10,000 bonus + regular depreciation
• Year 1 total: potentially $30,000+ in depreciation deductions

Check current bonus depreciation rates — they're scheduled to decrease each year.

Depreciation Recapture

When you sell a depreciated property, the IRS "recaptures" the depreciation you've claimed:

• Depreciation recapture is taxed at 25% (Section 1250)
• This is on top of any capital gains tax on the appreciation

Example:

• You claimed $87,270 in depreciation over 10 years
• Recapture tax at 25%: $21,818

Avoiding Recapture

• 1031 exchange — defer recapture by exchanging into another property
• Hold until death — heirs receive a stepped-up basis, eliminating recapture
• Never sell — refinance to access equity without triggering recapture

Depreciation and Your DSCR Loan

Depreciation doesn't affect your DSCR calculation — lenders use pre-tax cash flow. But it dramatically affects your after-tax return:

The property generating $3,600 in pre-tax cash flow pays zero tax — and creates a paper loss that may offset other income (subject to passive loss rules).

When to Start Depreciation

Depreciation begins when the property is "placed in service" — when it's ready and available for rent, whether or not it's actually occupied. You don't need a tenant to start depreciating.

The first year's depreciation is prorated based on the month placed in service:

• January placement: 11.5 months of depreciation
• June placement: 6.5 months
• December placement: 0.5 months

Tip: Close purchases before mid-month to maximize first-year depreciation.

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For related tax strategies, see our guides on cost segregation and tax deductions.