Real Estate Depreciation Explained: Ultimate Guide to Tax Deductions

Depreciation is one of the most powerful tax benefits available to real estate investors. It allows you to deduct a portion of your property's value each year, reducing taxable income—even when the property is actually appreciating in value. This "phantom expense" can save investors tens of thousands of dollars annually in taxes.

This comprehensive guide explains how real estate depreciation works, how to calculate it, strategies to maximize benefits, and what happens when you sell.

What Is Real Estate Depreciation?

Depreciation is a tax deduction that allows you to recover the cost of income-producing property over time. The IRS recognizes that buildings and improvements wear out, lose value, and eventually need replacement.

The Basic Concept

For rental properties:

• Purchase price: $500,000
• Land value: $100,000 (not depreciable)
• Building value: $400,000 (depreciable)
• Depreciation period: 27.5 years (residential)
• Annual deduction: $400,000 ÷ 27.5 = $14,545

Tax benefit: If you're in the 35% tax bracket, this $14,545 deduction saves you $5,091 in taxes annually—without spending a dollar.

Why Depreciation Exists

The tax code allows depreciation based on the theory that:

• Buildings deteriorate over time
• Components wear out and need replacement
• Investors should recover their capital investment
• Deductions match the "expense" of this deterioration

The beautiful irony: While you're deducting depreciation for tax purposes (claiming the building is losing value), your property is often appreciating in market value.

How Real Estate Depreciation Works

What Can Be Depreciated

Yes:

• Buildings and structures
• Improvements and renovations
• Appliances and equipment
• Landscaping (some elements)
• Parking lots and driveways
• Fencing
• HVAC systems

No:

• Land (never depreciates)
• Personal residence (unless rented out)
• Inventory (for developers/flippers)
• Property held for sale

Depreciation Periods

Residential Rental Property:

• 27.5 years (straight-line)
• Includes: apartments, single-family rentals, duplexes, condos

Commercial Property:

• 39 years (straight-line)
• Includes: office, retail, warehouses, mixed-use

Land Improvements:

• 15 years
• Includes: parking lots, sidewalks, landscaping, fencing

Personal Property:

• 5 years
• Includes: appliances, carpet, furniture, equipment

Note: These are for "straight-line" depreciation. Accelerated methods exist (see [cost segregation](/blog/depreciation-real-estate-guide) section).

Calculating Depreciation

Step 1: Determine Cost Basis

Your cost basis is the foundation for depreciation:

Purchase Price

• Contract price

• Closing costs
• Title insurance
• Legal fees
• Recording fees = Total cost basis

Example:

• Purchase price: $450,000
• Closing costs: $8,000
• Title/legal: $2,000
• Total basis: $460,000

Step 2: Allocate Between Land and Building

Land doesn't depreciate, so you must separate it:

Method 1: Tax Assessment

• Check property tax statement
• Shows land vs. improvement allocation
• Apply same ratio to your purchase

Example:

• Tax assessment: $400,000 total
• Land: $80,000 (20%)
• Building: $320,000 (80%)

Your allocation:

• Total basis: $460,000
• Land (20%): $92,000
• Building (80%): $368,000

Method 2: Appraisal

• Use purchase appraisal
• Often includes land/building breakdown
• Most accurate method

Method 3: Comparative Analysis

• Look at land sales in area
• Estimate land value
• Remainder is building

Step 3: Calculate Annual Depreciation

Formula: Annual Depreciation = Depreciable Basis ÷ Recovery Period

Residential example: $368,000 ÷ 27.5 years = $13,382/year

Commercial example: $368,000 ÷ 39 years = $9,436/year

Step 4: Apply Mid-Month Convention

IRS requires "mid-month convention"—you get half a month's depreciation for the month placed in service.

Example: Close in July

• July through December: 5.5 months
• Year 1 depreciation: $13,382 × (5.5 ÷ 12) = $6,133
• Years 2-27: Full $13,382
• Year 28: Remaining balance

Advanced Depreciation Strategies

Cost Segregation

Break property into components with shorter lives:

Traditional depreciation:

• Entire building: 27.5 years
• Annual: $13,382

With cost segregation:

• 5-year property: $100,000 (appliances, carpet)
• 15-year property: $150,000 (parking, landscaping)
• 27.5-year property: $118,000 (structure)

With 60% [bonus depreciation](/blog/depreciation-rental-property-guide) (2024):

• 5-year: $100,000 × 60% = $60,000
• 15-year: $150,000 × 60% = $90,000
• 27.5-year: $118,000 ÷ 27.5 = $4,291
• Year 1 total: $154,291 (vs. $13,382!)

Bonus Depreciation

Current law allows "bonus depreciation" on qualified property:

2024: 60% 2025: 40% 2026: 20% 2027+: 0% (unless extended)

Applies to:

• 5-year and 15-year property
• First year in service
• New and used property

Strategy: Use cost segregation before bonus depreciation phases out completely.

Section 179 Deduction

Immediate expensing for certain property:

Limits:

• Up to $1,220,000 (2024 limit)
• Personal property only
• Phases out above $3,050,000 in purchases

Useful for:

• Appliances
• Equipment
• Furniture
• Some improvements

Not for:

• Real property (buildings)
• Rentals to related parties in certain situations

Partial Asset Disposition

When you replace building components:

Traditional:

• Old roof sits on books until building sold
• No additional deduction

Partial disposition election:

• Dispose of old roof
• Write off remaining basis immediately
• Additional tax deduction

Example:

• Original roof cost: $50,000
• Depreciation taken: $15,000
• Remaining basis: $35,000
• Replace roof → take $35,000 loss immediately

Depreciation and Property Improvements

Capital Improvements vs. Repairs

Repairs (immediately deductible):

• Fix broken items
• Maintain current condition
• Return to working order
• Examples: fix leak, patch hole, paint

Capital Improvements (must depreciate):

• Add value
• Prolong life
• Adapt to new use
• Examples: new roof, addition, major remodel

Safe Harbor Rules:

De Minimis Safe Harbor:

• Items under $2,500
• Can expense immediately
• Even if technically capital improvement

Routine Maintenance Safe Harbor:

• Recurring activities
• Keep property in good condition
• Examples: annual HVAC service, repainting every 3 years

Small Taxpayer Safe Harbor:

• Building costs under $10,000 or 2% of building basis
• Can expense immediately
• Aggregate all improvements per building

Depreciating Improvements

When you renovate:

Add to basis:

• Improvement cost
• Depreciate over appropriate life
• 27.5 or 39 years (typically)
• Or segregate components for faster depreciation

Example:

• $100,000 kitchen renovation
• Add to building basis
• Depreciate: $100,000 ÷ 27.5 = $3,636/year

Better approach (cost segregation):

• Cabinets: 5-year property
• Appliances: 5-year property
• Flooring: 5-year property
• Plumbing: 15-year property
• Structure: 27.5-year property
• Accelerate deductions significantly

Passive Activity Loss Rules

The Limitation

Rental real estate is generally "passive activity":

• Losses can only offset passive income
• Can't offset W-2 wages or business income
• Excess losses suspended until:
  • You have passive income
  • You sell the property
  • You qualify for exceptions

$25,000 Special Allowance

For active participants:

• Can deduct up to $25,000 rental losses
• Against non-passive income
• Phases out: $100,000-$150,000 AGI
• Must actively participate (approve tenants, etc.)

Example:

• W-2 income: $120,000
• Rental loss (including depreciation): $30,000
• AGI: $150,000
• Allowable loss: $25,000 × (($150,000 - $100,000) ÷ $50,000) = $0
• Loss fully suspended (over phase-out limit)

Real Estate Professional Exception

Qualify as real estate professional:

• 750+ hours in real estate trades/businesses
• More than 50% of working time in real estate
• Material participation in rentals

Benefit:

• Rental activity becomes non-passive
• Losses offset any income (W-2, business, etc.)
• Depreciation can offset six-figure incomes
• Extremely powerful

Example:

• W-2 income: $200,000
• Rental depreciation (cost seg): $300,000
• Taxable income: -$100,000
• Tax due: $0 (plus refund of withholding)

This is why many high earners have spouses qualify as real estate professionals.

Depreciation Recapture

What Is Recapture?

When you sell, the IRS "recaptures" depreciation:

Depreciation recapture tax:

• Rate: 25% (maximum)
• Actually taxed at your ordinary income rate, capped at 25%
• Applied to all depreciation taken

Example:

• Owned 10 years
• Depreciation taken: $145,000
• Recapture tax: $145,000 × 25% = $36,250

How Recapture Works

Sale example:

• Original purchase: $500,000
• Depreciation taken: $145,000
• Adjusted basis: $355,000
• Sale price: $700,000
• Total gain: $345,000

Taxed as:

• Depreciation recapture: $145,000 × 25% = $36,250
• Capital gain: $200,000 × 20% = $40,000
• Total tax: $76,250

Plus:

• Net Investment Income Tax (3.8%): $13,110
• State taxes (varies)

Deferring Recapture

1031 Exchange:

• Roll property into replacement property
• Defer both capital gains AND recapture
• Can repeat indefinitely
• Step-up in basis at death eliminates entirely

Installment Sale:

• Spread gain over multiple years
• Recapture still due year of sale
• Doesn't defer recapture, just capital gains

Opportunity Zones:

• Defer original gain
• No impact on depreciation recapture
• Different strategy

Maximizing Depreciation Benefits

Strategy 1: Cost Segregation

When: Purchase or significantly improve property

Action:

• Hire cost segregation specialist
• Identify 5-year and 15-year components
• Accelerate depreciation
• Massive first-year deductions

Best for: Properties over $500,000

Strategy 2: [Real Estate Professional Status](/blog/real-estate-professional-status)

When: Spouse or you can dedicate time to real estate

Action:

• Track hours meticulously
• Exceed 750 hours in real estate
• Ensure more than 50% of working time
• Materially participate in rentals

Benefit: Offset any income with rental losses

Strategy 3: 1031 Exchange

When: Selling appreciated property

Action:

• Exchange into replacement property
• Defer all taxes (including recapture)
• Continue building portfolio
• Eventually step-up basis at death

Benefit: Never pay depreciation recapture

Strategy 4: Strategic Timing

Accelerate deductions:

• Purchase late in year (still get half-year depreciation)
• Complete improvements in high-income years
• Use bonus depreciation before it expires

Defer income:

• Delay sales to future years
• Match income with deductions
• Optimize tax brackets

Strategy 5: Proper Entity Structure

Considerations:

• LLCs offer pass-through taxation
• S-corps can provide salary flexibility
• Estate planning trusts offer [asset protection](/blog/real-estate-llc-guide)
• Consult CPA and attorney

Strategy 6: Short-Term Rentals

Special rule for STRs:

• If average stay < 7 days
• And you materially participate
• Losses may be non-passive
• Even without RE professional status

Benefit: Depreciation offsets other income

Common Depreciation Mistakes

Mistake 1: Not Taking Depreciation

Problem: "I'll skip depreciation to avoid recapture"

Why it's wrong:

• IRS assumes you took depreciation (even if you didn't)
• Must recapture "allowed or allowable" depreciation
• You lose deduction benefits but still pay recapture tax

Solution: Always take depreciation you're entitled to

Mistake 2: Depreciating Land

Land doesn't depreciate—only buildings and improvements.

Problem: Inflating depreciable basis

Solution: Use proper allocation methods (tax assessment, appraisal)

Mistake 3: Wrong Recovery Period

Problem: Using 39 years for residential

Solution:

• Residential: 27.5 years
• Commercial: 39 years
• Land improvements: 15 years
• Personal property: 5-7 years

Mistake 4: Not Tracking Improvements

Problem: Forgetting to depreciate renovations

Solution:

• Track all capital improvements
• Add to basis
• Begin depreciation
• Consider cost segregation for large projects

Mistake 5: Ignoring Partial Dispositions

Problem: Not writing off replaced components

Solution:

• Make partial disposition elections
• Immediate deduction for replaced items
• Additional tax benefit

Mistake 6: Missing Cost Segregation Opportunities

Problem: Standard depreciation on large properties

Solution:

• Consider cost segregation for properties $500K+
• Especially with bonus depreciation still available
• Retroactive studies possible

Depreciation and Financing

Impact on Cash Flow

Depreciation is a non-cash expense:

Example property:

• Rental income: $36,000
• [Operating expenses](/blog/net-operating-income-guide): $16,000
• Mortgage payment: $14,000
• NOI: $20,000
• Cash flow after debt: $6,000

Tax perspective:

• Rental income: $36,000
• Operating expenses: $16,000
• Mortgage interest (only): $10,000
• Depreciation: $18,000
• Taxable income: -$8,000 (loss!)

Result:

• Positive cash flow: $6,000
• Tax loss: $8,000
• Best of both worlds

DSCR Loans and Depreciation

DSCR loans (like those from HonestCasa):

• Based on property NOI, not personal income
• Depreciation doesn't affect NOI (non-cash)
• Lenders ignore depreciation for qualification
• Tax benefits independent of loan qualification

Advantage: Qualify based on property, enjoy tax benefits personally

Using HELOC for Improvements

Strategy:

• Use HELOC to fund improvements
• Depreciate improvement costs
• Tax deduction on depreciation
• Interest on HELOC also deductible
• Double tax benefit

Example:

• $100,000 HELOC at 7% = $7,000 annual interest
• $100,000 improvement depreciated = $20,000 first year (with cost seg)
• Total deductions: $27,000
• Tax savings (35% bracket): $9,450

HonestCasa's competitive HELOC rates make this strategy even more attractive.

Record Keeping

Essential Documentation

Purchase:

• Closing statement
• Purchase agreement
• Appraisal
• Property tax assessment
• Title documents

Annual:

• Depreciation schedules
• Improvement receipts
• Repair vs. improvement classifications
• Cost segregation studies

Sale:

• Sale closing statement
• 1031 exchange documentation
• Final depreciation schedule
• Gain/loss calculation

Software and Tools

Depreciation tracking:

• Tax software (TurboTax, TaxAct)
• [[Property management](/blog/property-management-complete-guide) software](/blog/best-property-management-software-2026)
• Spreadsheets
• CPA-provided schedules

Best practice: Maintain separate folder for each property with all depreciation-related documents.

Related Articles

• Cost Segregation Study Guide
• Depreciation Recapture Explained
• Rental Property Depreciation Schedule: A Complete Investor's Breakdown
• Complete Guide to Homeowner Tax Benefits in 2026
• Real Estate Depreciation Guide

Frequently Asked Questions

Can I claim depreciation on my primary residence?

No. Primary residences aren't eligible for depreciation deductions. However, if you convert your home to a rental property, you can begin depreciating it from that point forward. The depreciable basis is the lower of: (1) adjusted basis at conversion, or (2) fair market value at conversion.

What happens if I forgot to take depreciation in previous years?

You must file Form 3115 (Change in Accounting Method) to "catch up" missed depreciation. This lets you take all the missed deductions in one year without amending prior returns. The IRS will still assume you took depreciation for recapture purposes, so there's no benefit to skipping it—you must catch up.

How does depreciation work with a 1031 exchange?

When you do a 1031 exchange, your depreciation basis carries over to the new property. You continue depreciating the original basis plus any additional capital invested. The exchange defers depreciation recapture—you don't pay it until you eventually sell outside of a 1031. Many investors exchange properties repeatedly and never pay recapture.

Can I depreciate a property I inherited?

Yes, but the rules differ. Inherited property receives a "step-up in basis" to fair market value at death. This becomes your new depreciable basis. Previous depreciation is forgiven—no recapture. You begin fresh depreciation schedule from date of inheritance. This is why 1031 exchanges plus eventual inheritance is such a powerful strategy.

Is depreciation worth it if I have to recapture it later?

Absolutely! The time value of money makes early deductions worth far more than later taxes. If you deduct $20,000 annually for 10 years (saving $7,000/year in taxes), that's $70,000 in tax savings. When you sell, you pay 25% recapture on $200,000 = $50,000. You're ahead $20,000 plus you had use of that money for years to invest and compound.

How does cost segregation affect depreciation?

Cost segregation accelerates depreciation by reclassifying building components into shorter recovery periods (5 or 15 years vs. 27.5/39 years). This frontloads deductions—you get more depreciation in early years and less in later years, but total depreciation over time remains the same. The benefit is the time value of earlier tax savings.

Can I use depreciation if I'm not a real estate professional?

Yes, but with limitations. Depreciation losses are "passive" and can only offset passive income unless you qualify for the $25,000 special allowance (which phases out at higher incomes) or real estate professional status. However, suspended passive losses carry forward indefinitely and fully deduct when you sell the property.

How do DSCR loans work with depreciation deductions?

DSCR loans from HonestCasa are based on property cash flow (NOI ÷ debt service), not taxable income. Depreciation is a non-cash expense that doesn't affect NOI or [DSCR calculation](/blog/how-to-calculate-dscr). This means you can qualify for a DSCR loan based on strong property performance while simultaneously enjoying large depreciation deductions that reduce your personal taxable income.

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Real estate depreciation is one of the most valuable tax benefits available to investors, allowing you to deduct hundreds of thousands of dollars while your property appreciates in value. Understanding how depreciation works, maximizing benefits through strategies like cost segregation, and properly navigating recapture rules can save you six figures in taxes over your investing career.

Whether you're financing with conventional loans, DSCR loans, or HELOCs from HonestCasa, depreciation enhances your after-tax returns and cash flow. Work with a knowledgeable CPA to ensure you're capturing every available deduction and structuring your investments for maximum tax efficiency.