Real Estate Depreciation Guide: How to Maximize Your Tax Deductions in 2026

Real estate depreciation is one of the most powerful tax advantages available to property investors, yet many investors either don't use it properly or don't understand how much money it can save them.

Here's the bottom line: if you own a $400,000 rental property, you could be deducting approximately $14,545 every year from your taxable income—even while your property appreciates in value. Over 27.5 years, that's $400,000 in tax deductions that can save you $80,000-$150,000 in taxes depending on your tax bracket.

This comprehensive guide will show you exactly how real estate depreciation works, how to calculate it, and advanced strategies like cost segregation that can accelerate your deductions and put money back in your pocket faster.

What Is Real Estate Depreciation?

Depreciation is a tax deduction that allows you to recover the cost of an income-producing property over time. The IRS recognizes that buildings and their components wear out, so they allow you to deduct a portion of the property's value each year.

Key concept: Land doesn't depreciate (it doesn't wear out), but buildings and improvements do.

IRS depreciation periods:

• Residential rental property: 27.5 years
• Commercial property: 39 years
• Land improvements: 15 years (driveways, fences, landscaping)
• Personal property: 5-7 years (appliances, furniture)

Who Can Claim Depreciation?

You can claim depreciation if you meet all these requirements:

1. You own the property (or have another ownership interest)
2. You use it to produce income (rental, business use)
3. It has a determinable useful life (buildings yes, land no)
4. It's expected to last more than one year

Properties that qualify:

• Single-family rental homes
• Multi-family apartment buildings
• Commercial buildings
• Vacation rentals (if rented 14+ days per year)
• Mixed-use properties (business portion only)
• Equipment and furnishings in rental properties

Properties that don't qualify:

• Your primary residence (unless you have a home office)
• Land (it doesn't wear out)
• Properties held for resale (fix-and-flip)
• Properties not yet placed in service

How to Calculate Depreciation

Step 1: Determine Your Cost Basis

Your cost basis is the starting point for depreciation calculations.

Cost basis includes:

• Purchase price of the property
• Closing costs (title insurance, legal fees, recording fees)
• Transfer taxes and stamp duties
• Cost of improvements made before placing in service

Cost basis does NOT include:

• Land value (not depreciable)
• Mortgage interest
• Property taxes
• Insurance premiums
• Ongoing repairs and maintenance

Example calculation:

• Purchase price: $400,000
• Closing costs: $8,000
• Total cost: $408,000
• Land value: $80,000 (20% of purchase price)
• Depreciable basis: $328,000

Step 2: Separate Land from Building Value

Since land doesn't depreciate, you must allocate your purchase price between land and building.

Methods to determine land value:

1. Property tax assessment: Most accurate and IRS-accepted

   • Building assessment: $320,000
   • Land assessment: $80,000
   • Land is 20% of total ($80,000 ÷ $400,000)
   • Apply this 20% to your purchase price

2. Appraisal: Professional appraiser separates values

   • Cost: $300-500
   • Most defensible in an audit

3. Comparable sales: Research similar land-only sales in your area

Conservative approach: Use 15-25% for land value in most residential areas. Urban areas may be higher (30-40%), rural areas lower (10-20%).

Step 3: Calculate Annual Depreciation

For residential rental property, divide the depreciable basis by 27.5 years.

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

Example:

• Purchase price: $400,000
• Land value (20%): $80,000
• Building value: $320,000
• Annual depreciation: $320,000 ÷ 27.5 = $11,636 per year

Monthly calculation: If you place the property in service mid-year, use the mid-month convention. You get a half-month for the month placed in service.

• Property placed in service: July 15, 2026
• Months in service: 5.5 (July through December)
• Year 1 depreciation: $11,636 × (5.5 ÷ 12) = $5,333

Cost Segregation: Accelerate Your Depreciation

Cost segregation is an advanced strategy that can dramatically increase your first-year deductions by reclassifying building components into shorter depreciation periods.

How Cost Segregation Works

Instead of depreciating the entire building over 27.5 years, you identify components that can be depreciated over 5, 7, or 15 years:

5-year property:

• Carpets and flooring
• Appliances (refrigerators, dishwashers, ranges)
• Decorative light fixtures
• Window treatments

7-year property:

• Office furniture and equipment
• Some landscaping
• Decorative items

15-year property:

• Land improvements (driveways, sidewalks, fences)
• Outdoor lighting
• Landscaping
• Swimming pools (for apartments)

27.5-year property:

• Building structure
• Roof
• HVAC systems
• Plumbing and electrical (if integral to building)

Cost Segregation Example

Property purchase: $500,000 (excluding land)

Without cost segregation:

• Entire building: $500,000 ÷ 27.5 years = $18,182/year

With cost segregation:

• 5-year property (15%): $75,000 ÷ 5 = $15,000/year
• 15-year property (10%): $50,000 ÷ 15 = $3,333/year
• 27.5-year property (75%): $375,000 ÷ 27.5 = $13,636/year
• Total first year: $31,969 (vs. $18,182 = $13,787 additional deduction)

When Cost Segregation Makes Sense

Best candidates:

• Properties purchased for $500,000+
• Recently purchased properties (within last 3 years)
• Properties with significant improvements
• Investors with high taxable income needing deductions
• Properties with unique features (pools, high-end finishes)

Cost:

• Professional study: $5,000-$15,000
• Engineering-based analysis and detailed report
• Must be defensible in an IRS audit

Return on investment: If a $10,000 cost segregation study generates $30,000 in additional first-year deductions, and you're in the 32% tax bracket, you save $9,600 in taxes—nearly paying for itself immediately, with benefits continuing for years.

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

The Tax Cuts and Jobs Act introduced 100% bonus depreciation (gradually phasing down), allowing you to deduct the full cost of qualified property in year one.

2026 Bonus Depreciation Rate: 40% (Phasing schedule: 100% in 2022, decreasing 20% annually)

Qualified property:

• Personal property (5, 7, 15-year assets)
• Acquired and placed in service after September 27, 2017
• New or used property

Example with bonus depreciation:

• 5-year property identified through cost segregation: $75,000
• Bonus depreciation (40% in 2026): $75,000 × 40% = $30,000
• Remaining basis: $45,000
• Regular first-year depreciation: $45,000 ÷ 5 = $9,000
• Total first-year deduction: $39,000

Section 179 Expensing

Section 179 allows immediate expensing of certain property up to $1,220,000 (2026 limit, adjusted for inflation).

Qualifications:

• Personal property and equipment
• Property used more than 50% for business
• Must have business income to offset

Limitations:

• Deduction cannot exceed business income
• Phase-out begins when total equipment purchases exceed $3,050,000 (2026)

Best uses for real estate:

• Appliances in rental units
• Furniture in [furnished rentals](/blog/dscr-loan-midterm-rental)
• Office equipment
• Landscaping equipment
• Security systems

[Passive Activity Loss Rules](/blog/rental-property-tax-guide-2026)

Understanding passive activity loss rules is critical for utilizing depreciation deductions.

Key rules:

1. Rental activities are generally passive - Losses can only offset passive income
2. $25,000 special allowance - Active participants can deduct up to $25,000 in passive losses against ordinary income
3. Income phase-out - Allowance phases out between $100,000-$150,000 AGI (modified adjusted gross income)
4. [Real estate professional status](/blog/real-estate-professional-status) - Allows unlimited passive loss deductions if you qualify

Real Estate Professional Status

To qualify as a real estate professional (and avoid passive loss limitations):

1. More than 50% of your personal services are performed in real property trades or businesses
2. More than 750 hours per year in real property activities
3. Material participation in the rental activity (100+ hours if no one else spends more time)

Why it matters:

• Regular investor: Limited to $25,000 passive loss deduction (if under income limits)
• Real estate professional: Unlimited passive loss deductions against ordinary income

Example:

• Depreciation and expenses create $50,000 loss
• Regular W-2 income: $200,000
• Non-professional: $0 deduction (over income limit), loss carries forward
• RE professional: $50,000 deduction, saves $16,000 in taxes (32% bracket)

Depreciation Recapture: What You Need to Know

When you sell a depreciated property, you must "recapture" the depreciation you claimed, paying tax on it at a maximum rate of 25%.

How Depreciation Recapture Works

Example:

• Purchase price: $400,000 (building: $320,000)
• Depreciation claimed over 10 years: $116,364
• Adjusted basis: $283,636
• Sale price: $500,000
• Gain: $216,364

Tax calculation:

• Depreciation recapture: $116,364 × 25% = $29,091
• Capital gain (above original price): $180,000 × 15-20% = $27,000-$36,000
• Total tax: $56,091-$65,091

Strategies to Avoid or Defer Recapture

1. 1031 Exchange

• Exchange into another investment property
• Defer all taxes (including depreciation recapture)
• Continue depreciation basis from old property
• Can defer indefinitely through multiple exchanges

2. Installment Sale

• Spread recapture tax over multiple years
• Match tax payments with installment receipts
• Better cash flow management

3. Opportunity Zones

• Invest capital gains in qualified opportunity zones
• Defer gains until 2026 or sale of OZ investment
• Potential elimination of gains if held 10+ years

4. Hold Until Death

• Heirs receive stepped-up basis
• Eliminates depreciation recapture entirely
• Also eliminates capital gains tax
• "Buy, borrow, die" strategy

Common Depreciation Mistakes

1. Not Claiming Depreciation

Some investors think they can skip depreciation to avoid recapture. Wrong. The IRS requires you to recapture "allowed or allowable" depreciation—even if you never claimed it.

Example:

• You owned a rental 10 years but never claimed depreciation
• You sell the property
• IRS still treats you as if you claimed $116,364 depreciation
• You pay recapture tax but got no benefit

Lesson: Always claim depreciation. You'll pay the tax either way.

2. Depreciating Land

Land is not depreciable. Including land in your depreciation calculations will trigger corrections and penalties in an audit.

3. Incorrectly Categorizing Repairs vs. Improvements

Repairs: Deductible immediately (fixing a leak, painting) Improvements: Must be depreciated (new roof, kitchen remodel)

Safe harbor for small taxpayers:

• If your average annual gross receipts are $10 million or less
• You can deduct improvements up to $10,000 per invoice (or item)
• Must make election on tax return

4. Not Tracking Basis Adjustments

Every improvement increases your basis and should be depreciated separately.

Example:

• Original building: $320,000
• New roof in year 5: $15,000
• New roof depreciates over 27.5 years starting in year 5
• Keep detailed records of all improvements and their placed-in-service dates

5. Forgetting About Partial Dispositions

When you replace a building component (roof, HVAC, flooring), you should dispose of the old component for tax purposes.

Partial disposition benefits:

• Write off remaining basis of replaced component
• Creates immediate deduction
• Reduces total basis (lower recapture upon sale)

Example:

• Replaced roof originally cost $12,000 (20 years ago)
• Remaining undepreciated basis: $3,000
• [New roof cost](/blog/roof-replacement-cost): $15,000
• Year 1 benefit: $3,000 write-off + first year of new roof depreciation

Maximizing Your Depreciation Strategy

Strategy 1: Purchase Properties Late in the Year

The mid-month convention means you get a half-month of depreciation for the month placed in service.

• Purchase in January: ~11.5 months of depreciation
• Purchase in December: ~0.5 months of depreciation

However, don't let the tax tail wag the investment dog. A good deal in December is better than waiting for January.

Strategy 2: Segregate Personal Property

Separately state personal property in your purchase agreement:

"Purchase price $400,000, including:

• Real property: $385,000
• Appliances: $8,000
• Washer/dryer: $3,000
• Window coverings: $4,000"

Personal property depreciates over 5-7 years vs. 27.5 years.

Strategy 3: Cost Segregation in High-Income Years

Time your cost segregation study for years when you have high income and can use the additional deductions.

Strategy 4: Keep Impeccable Records

Document everything:

• Purchase agreements and closing statements
• Improvement invoices and receipts
• Photos of property conditions
• Cost segregation studies
• Depreciation schedules

Store digitally with cloud backup. These records are critical for audits and eventual sale.

Frequently Asked Questions

Q: Can I claim depreciation on my primary residence? A: No, unless you use part of it for business (home office) or rental (renting a room). Only the business/rental portion is depreciable.

Q: What happens if I convert my primary residence to a rental property? A: You can begin depreciating it from the date of conversion. Your basis is the lesser of (a) fair market value on conversion date or (b) original cost plus improvements.

Q: Can I claim depreciation on a property I'm fixing up before renting? A: Depreciation begins when the property is "placed in service"—ready and available for rent. Fix-up costs are added to basis and depreciated from that date.

Q: Do I have to recapture depreciation if I sell at a loss? A: No. Depreciation recapture only applies to the extent you have a gain. If your sale price is less than your adjusted basis, there's no recapture.

Q: Can I claim both depreciation and repairs on the same property? A: Yes. Depreciation is automatic for the building. Repairs are separately deductible as [operating expenses](/blog/net-operating-income-guide).

Q: How does depreciation work with a property I inherited? A: Inherited property receives a stepped-up basis (fair market value on date of death). You can depreciate this new basis over 27.5 years, with no recapture of previous owner's depreciation.

Q: What if I forgot to claim depreciation in previous years? A: File Form 3115 (Change in Accounting Method) to claim missed depreciation. You can catch up on prior years in the current year.

Q: Is a cost segregation study worth it for a $300,000 property? A: Generally no. Cost studies typically cost $5,000-$15,000, which may not be justified by the additional deductions on a $300,000 property. Better for properties $500,000+.

Take Control of Your Depreciation Deductions

Real estate depreciation is not optional—it's a required tax strategy that can save you tens of thousands of dollars over the life of your investment property. Whether you're claiming basic depreciation or using advanced strategies like cost segregation and bonus depreciation, understanding these rules is essential to maximizing your returns.

Action steps:

1. Calculate your current depreciation deductions on all rental properties
2. Consider a cost segregation study for properties over $500,000
3. Review whether you qualify as a real estate professional
4. Ensure you're tracking basis adjustments for all improvements
5. Consult with a CPA experienced in real estate taxation

Ready to Optimize Your [Real Estate Tax Strategy](/blog/1031-exchange-for-beginners)?

HonestCasa provides real estate investors with the tools, education, and support to make smarter tax decisions and build long-term wealth. From depreciation strategies to 1031 exchanges and entity structuring, we help you keep more of what you earn.

Get Started with HonestCasa and discover how to maximize your [real estate tax advantages](/blog/tax-benefits-of-real-estate-investing) while staying fully compliant with IRS regulations.

Related Articles

• 1031 Exchange for Beginners: Complete Guide to Deferring Capital Gains Taxes
• 1031 Exchange: Defer Taxes, Build Wealth Faster
• Cost Segregation Study Guide: How Real Estate Investors Accelerate Depreciation to Save Thousands