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ContinueComplete guide to rental property depreciation: calculate your deductions, understand the 27.5-year timeline, avoid recapture taxes, and maximize ROI.
Rental property depreciation is one of the most powerful tax deductions available to real estate investors. This IRS-approved accounting method allows you to deduct the cost of your rental property over 27.5 years, potentially saving thousands of dollars in taxes annually even when your property appreciates in value.
Here's how it works: The IRS assumes your rental property loses value over time due to wear and tear. For residential rentals, you can deduct approximately 3.636% of the property's value each year (excluding land) as a depreciation expense. This reduces your taxable rental income, lowering your overall tax bill.
However, the IRS has specific rules about how to calculate depreciation on rental property, when you can start claiming it, and what happens when you sell (depreciation recapture).
This guide breaks down everything you need to know about real estate depreciation, including step-by-step calculations, eligibility requirements, and strategies to maximize your deductions while staying compliant.
Contents
Professional guidance recommended for complex situations like cost segregation studies, converted personal residences, or mixed-use properties
In episode 10, guests Amanda Han and Matt MacFarland take us through the ins and outs of depreciation, cost segregation, and how record keeping is the foundation of any tax strategy.
Matt MacFarland and Amanda Han are both licenced CPA's, they are the founders and managing directors of Keystone CPA, and are both seasoned real estate investors and are the authors of "The Book on Advanced Tax Strategies: Cracking the Code for Savvy Real Estate Investors" which you can buy on Amazon here.
To claim depreciation deductions on your rental property, your investment must meet specific IRS eligibility requirements. Understanding these criteria ensures you're maximizing your deductions while staying compliant.
According to Matt MacFarland, CPA and co-founder of Keystone CPA:
"You're a landlord, you bought a building—obviously you're buying it for cash flow, you're buying it for the property to appreciate in value—but in the IRS's eyes, because of normal wear and tear, they think it's going down in value. So they let you write off a portion of the purchase price of the building every year against your income from the property."
Your property qualifies for depreciation if it meets all four of these conditions:
1. You own the property
You must hold legal title to the property. This applies even if you have a mortgage—the property is still considered yours for depreciation purposes.
2. The property generates income
The property must be used for business purposes or income production. This includes traditional rentals, vacation rentals, or commercial use. Properties used solely for personal purposes don't qualify.
3. The property has a determinable useful life
The IRS must be able to define how long the property will remain useful. Residential rental properties have a useful life of 27.5 years, while commercial properties are depreciated over 39 years.
4. The property will last more than one year
You must intend to own and use the property for business purposes for at least 12 months. If you flip a property within the same tax year you purchase it, depreciation doesn't apply.
Amanda Han also weighed in: "I think what I also love about depreciation is that it is available to all types of Real Estate Investors... Anybody who invests in rental real estate is able to take depreciation and depreciation can offset rental income every single year."
Only the building structure is depreciable, not the land.
The IRS views land as an appreciating asset that doesn't wear out or lose value over time. This means you must separate the land value from your total purchase price when calculating your depreciation basis.
What this means in practice:
For example, if you purchase a rental property for $400,000 and the land is valued at $100,000, only the remaining $300,000 (the structure) is depreciable. Your tax assessment or a professional appraisal can help you determine the appropriate land-to-building ratio.
Generally speaking, you can begin the process of depreciation as soon as the property is placed in service. For a rental property, this means when the property is ready and available to use as a rental which is evidenced by the date you actively start looking for tenants.
For example, you buy a property on the 1st of January. The property needs some work is done which takes 3 months to complete. On the 1st of April, you put the property on the market, advertise online, etc., and start actively looking for tenants. You find a tenant and they move on the 1st of May.
In this scenario, you can begin depreciating the property on the 1st of April, as this is when it is deemed to have been placed in service, ready for use.
You can then continue to depreciate the property until you have either deducted the entire cost, spread over those 27.5 years or you sell or dispose of the property, retiring it from service.
Calculating rental property depreciation is more straightforward than it seems. All property placed in service after 1986 is depreciated using the Modified Accelerated Cost Recovery System (MACRS), an accounting technique that spreads costs (and depreciation deductions) over 27.5 years for residential rentals.
Start with the total amount you paid to acquire the property. This is typically the sale price shown on your closing statement.
Example: You purchase a single-family rental home for $350,000.
Only the building structure can be depreciated—land is excluded. You'll need to determine what portion of your purchase price represents the building versus the land.
How to find your land value:
Example: Your property tax statement shows:
Building value = $280,000 (this is what you'll depreciate)
Your cost basis includes more than just the building value. Certain closing costs and settlement fees can be added to increase your depreciable amount.
Qualifying closing costs you can include:
Important: You cannot include loan-related costs (origination fees, points, mortgage interest) in your cost basis—these are deducted separately as rental expenses.
Example calculation:
Once you have your cost basis, the calculation is simple. For residential rental properties, divide your cost basis by 27.5 years.
Annual Depreciation = Cost Basis ÷ 27.5 years
For monthly depreciation: Annual Depreciation ÷ 12
Example calculation:
There's one catch: In the first and last year of ownership, you can't claim a full year of depreciation. The IRS uses a "mid-month convention," which means you can only claim depreciation starting from the middle of the month when the property was placed in service.
Example: If your property was placed in service in June:
In subsequent years, you claim the full $10,431 annual deduction until you reach the 27.5-year mark or sell the property.
Most residential rental property owners use the General Depreciation System (GDS), which depreciates properties over 27.5 years using straight-line depreciation.
However, you must use the Alternative Depreciation System (ADS) if your property:
ADS uses a 30-year recovery period instead of 27.5 years (reduced from 40 years by the 2017 Tax Cuts and Jobs Act), resulting in smaller annual deductions. Unless your property falls into one of these special categories, you'll use the standard GDS method.
Related: How to Calculate Depreciation on a Rental Property [+Free Spreadsheet]
Your rental property cost basis is the initial value from which any future depreciation is taken. This is worked out by calculating the overall value of the property itself independent of the cost of the land and including certain qualified closing costs.
Matt MacFarland explained: "Buy a million dollar property, put $100,000 down—depreciation is based on a million [dollars], not just your $100,000 down payment. That's why you call it a paper write-off, because it's not money that you're spending every year."
Cost Basis = Property Purchase Price - Land Value + Qualifying Closing Costs
The starting point depends on how you acquired the property:
If you purchased it as a rental investment: Use the purchase price from your closing statement.
If you converted a personal residence: You'll need a professional appraisal to establish fair market value at the time of conversion.
If you inherited the property: The cost basis is typically the fair market value on the date of the previous owner's death (stepped-up basis).
Remember: only the building structure is depreciable. You must separate and exclude the land value from your cost basis. Find this information on your property tax assessment, purchase appraisal, or through your local tax assessor's office.
You can also add certain settlement fees and qualified closing costs, increasing your depreciable amount.
These include:
✓ Costs you can include:
✗ Costs you cannot include:
Important: If you add property taxes to your cost basis, you cannot also deduct them as rental expenses on your tax return—it's one or the other.
Scenario: You purchase a rental property and need to determine your depreciable basis.
Purchase price: $260,000
Less: Land value - $60,000
Plus: Qualifying closing costs + $5,000
Total Cost Basis: $205,000
This $205,000 is the amount you'll depreciate over 27.5 years.
Annual depreciation: $205,000 ÷ 27.5 = $7,455 per year
The next step involves determining which of the two MACRS applies: the General Depreciation System (GDS) or the Alternative Depreciation System (ADS). GDS applies to most properties placed in service, and in general, you must use it unless you make an irrevocable election for ADS or the law requires you to utilize ADS.
ADS is mandated when the property:
Again, it’s recommended that you consult a qualified tax accountant, who can help you determine the most favorable way to depreciate your rental property.
While standard depreciation spreads deductions evenly over 27.5 years, accelerated depreciation methods allow you to claim larger deductions in the early years of property ownership—potentially saving tens of thousands in taxes upfront.
The most powerful accelerated depreciation strategy for rental property owners is a cost segregation study. This detailed engineering analysis seperates your property into different asset categories with shorter depreciation timelines.
Example impact: A $500,000 rental property might identify $150,000 in assets eligible for 5-7 year depreciation instead of 27.5 years. This accelerates roughly $100,000+ in deductions to the first five years instead of spreading them over nearly three decades.
Bonus depreciation allows you to deduct a percentage of qualifying property costs in the first year. However, this benefit is phasing out: 60% in 2024, 40% in 2025, 20% in 2026, and eliminated in 2027. It typically applies to property with recovery periods of 20 years or less—making cost segregation essential to maximize this benefit.
Amanda Han: "It's really important for investors to understand that cost segregation is not the right solution for every single person—it is very investor specific... You only want to do accelerated depreciation if you are able to utilize it in the year that you create this deduction."
Consider accelerated methods if you:
Cost consideration: Cost segregation studies typically cost $5,000-$15,000 but can generate $50,000-$200,000 in accelerated deductions, making them worthwhile for higher-value properties.
Learn more about accelerated depreciation strategies →
Depreciation recapture is a process put in place by the IRS to recapture some of the deducted value of the property when you sell it. According to these rules, the amount deducted over time through depreciation is treated as capital gains which are taxed at a specific depreciation recapture rate when the property is sold.
In 2019, depreciation recapture on gains related to the sale of the property was capped at a maximum of 25%. The rest will be taxed at the long-term capital gains rate according to your income level. If you’re a higher-income taxpayer, you may also be on the hook for a 3.8% net investment income tax.
Let’s run through a simple example.
You buy a property for $100,000. You use it as a rental property for 10 years. You claim a deduction of $3,636 each year the property is in service.
The property then sells after 10 years for $150,000. Upon the sale of the property, you will need to pay capital gains tax on the profit. In this scenario, because you depreciated the property for 10 years you would make a profit of $50,000 plus the $3,636 x 10 years, making a total taxable capital gain of $86,360
This taxable gain would then be subject to two different tax rates. $36,360 would be subject to the depreciation recapture rate of up to 25% and the remaining $50,000 would be subject to your long-term capital gains rate of 0%, 15%, or 20% depending on your income level.
Depreciation recapture is reported on Internal Revenue Service (IRS) Form 4797.
You might be looking at a loss if you have to sell a rental home in a down market or have just had to put more money into a property than it is worth. If you do make a loss when selling your property depreciation recapture doesn’t apply. However, you need to make sure you have correctly worked out your net gain or loss.
To determine if you have a tax gain or loss, you will need to compare the property’s sale price to its tax basis. The tax basis is generally your original purchase price, plus the cost of improvements (not counting expenses you’ve deducted as repairs and maintenance), minus any depreciation deductions you claimed while you owned it.
For example, you bought a property for $200,000 depreciated $58,000 over 8 years, and then sold the property for $150,000. This might look like a big loss, however, it would actually be an $8,000 gain which would be subject to depreciation recapture.
It might seem reasonable that if you were to avoid claiming depreciation you could avoid the recapture tax hit. However, this strategy doesn’t work because tax law requires that recapture be calculated on depreciation that was “allowed or allowable,” according to Internal Revenue Code section 1250(b)(3).
In other words, you were entitled to claim depreciation even if you didn’t, so the IRS treats the situation as though you had. From a tax-planning perspective, taxpayers should generally claim depreciation on the property to get the currently associated tax deduction because they’ll have to pay tax on the gain due to the depreciation anyway when they eventually sell.
What you can do however is delay capital gains by taking advantage of Section 1031 of the IRS tax code. Commonly referred to as a 1031 exchange, this section allows investors to defer paying taxes when they sell investment real estate, instead, they are allowed to reinvest the proceeds from the sale in a real estate investment of equal or greater value. You should always contact a 1031 exchange specialist before selling your property.
Investing in real estate is a great way to build wealth through an appreciating asset and achieve financial freedom. The US currently has some very favorable tax laws for real estate investors which makes it very possible to make great returns through rental properties.
Amanda Han: "To truly save on taxes, to have a good tax plan in place, the foundation of it is to have good books. Because if you don't have good books, then you don't know where your starting point is."
To ensure you make the most out of your real estate investments and properly take advantage of all the deductible expenses available to you need to make sure you accurately and efficiently track your income and expenses, including things like rental property depreciation, and keep well-organized records for future reference.
The examples used in this article are simplified to explain the basics of depreciation and depreciation recapture. There are additional things to consider such as depreciating the costs of improvements to a property.
Additionally, rental property tax laws are subject to frequent changes which further complicates matters. As such, even if you’re familiar with and comfortable with filing your taxes, it is always recommended that you consult with a skilled and knowledgeable tax professional. Doing so will allow you to properly take advantage of the favorable tax laws and avoid any nasty surprises.
Stay on top of your rental property accounting and ensure you're maximizing your end of year deductions with property management and accounting software designed for you. Create your free Landlord Studio account today.
Residential rentals depreciate over 27.5 years under MACRS (GDS). Commercial property uses 39 years.
If you must use ADS, residential rentals depreciate over 30 years. Depreciation stops when you sell or fully recover your basis.
About 3.636% per year (1 ÷ 27.5). A $200,000 building generates roughly $7,273 in annual depreciation.
No. Only the building and improvements are depreciable. Land, landscaping, and site work are not.
When the property is placed in service—ready and available to rent—even if no tenant has moved in yet.
You’ll owe depreciation recapture (up to 25%) on the amount depreciated. However, most landlords still come out ahead due to years of tax savings at higher ordinary income rates.
You can defer, not eliminate, recapture through:
You still owe recapture on depreciation that was “allowed or allowable.” Skipping depreciation means you lose the deduction but still pay the tax—a costly mistake.
Yes. Capital improvements (roof, HVAC, remodels, additions) increase basis and are depreciated over 27.5 years. Repairs and routine maintenance are expensed immediately.
Not for simple rentals. However, depreciation can quickly become complex and it's important to get itright. You will want to consult a licenced professional if you have any doubts and likely need to hire a CPA if you have cost segregation, inherited property, mixed-use property, a residence-to-rental conversion, or are planning a 1031 exchange.
Yes. Your basis resets to the fair market value on the date of death (stepped-up basis). Subtract land value and depreciate the building over a fresh 27.5-year period.
Here are some additional resources from the IRS website regarding depreciation that you might find helpful and informative:
Disclaimer
We hope you found this blog interesting! However, do note that the information in this article does not constitute advice. This blog is for general informational and educational purposes only and should not be used as a substitute for competent legal and/or other advice from a licensed professional.
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