How to Calculate Depreciation on a Rental Property [+Free Spreadsheet]

Rental property depreciation is a tax strategy that allows landlords to offset the cost of acquiring and improving a property by deducting a portion of its value (or the value of the improvements) over what the IRS deems its ‘useful life’. Essentially, the IRS allows property owners to deduct an annual depreciation expense against their taxable income for each full year the property is rented out.

Understanding rental property depreciation is essential, as it can lead to significant tax savings and help manage long-term expenses.

In this article, we’ll break down how to calculate depreciation on a rental property, explain how depreciation works, and share strategies to avoid depreciation recapture. Plus, we’re offering a free downloadable rental property depreciation spreadsheet to streamline your calculations.

Understanding Depreciation in Rental Property

For residential rental properties, depreciation is deducted over 27.5 years, while commercial properties have a 39-year recovery period—the IRS-defined "useful life" of the asset. Only the building, not the land, can be depreciated since land does not lose value.

Essentially, depreciation allows property owners to deduct the gradual decline in a building’s value due to usage, wear and tear, and obsolescence. These deductions continue annually until the property is sold or its full cost basis is recovered.

Property owners can claim depreciation as long as they own the rental property and generate income from it and can start claiming depreciation as soon as the property is ‘placed in service’ - made available to rent. This means that if you use the property for business purposes or as a source of rental income, it not only has a useful life but is also expected to last beyond one year.

This tax benefit spreads deductions over multiple years, reducing taxable income without requiring an immediate expense. In addition to depreciation, there are various other real estate tax deductions available that can further lower your annual tax bill. Effective expense management can simplify the process of claiming depreciation and other tax deductions and maximizing cash flow.

For more information read our article: Understanding Rental Property Depreciation and Depreciation Recapture

How to Depreciate a Rental Property?

Depreciation on a rental property begins as soon as it is ready for rent or designated for commercial use. If you start renting your property partway through a calendar year, the depreciation for that initial year will be prorated based on the months it was available for rental.

To determine how much depreciation you can claim, refer to IRS Publication 527, which provides guidelines for residential rental properties. Once your property has been in service for more than one year, you can depreciate it at a consistent rate of 3.636% annually for up to 27.5 years.

Important: Only the value of the building itself can be depreciated; the land on which it sits is not eligible for depreciation.

Methods To Calculate Depreciation In Real Estate

The IRS employs two systems under the Modified Accelerated Cost Recovery System (MACRS) to calculate depreciation on rental properties. Before calculating depreciation, you must identify which system applies to your property.

Method 1: General Depreciation System (GDS)

The General Depreciation System (GDS) is the most commonly used method for calculating rental property depreciation. It applies to most properties unless specific circumstances require the use of the Alternative Depreciation System (ADS). Under GDS, residential properties can be depreciated over a standard period of 27.5 years.

Method 2: Alternative Depreciation System (ADS)

The Alternative Depreciation System is applicable in certain situations, such as:

• The building is used for qualifying business purposes less than 50% of the time
• The property is primarily utilized for farming
• The building is financed with tax-exempt bonds
• The property generates income that is itself tax-exempt

The choice of system affects the length of the depreciation recovery period. Under ADS, if the entire property generates rental income after December 31, 2017, the recovery period is set at 30 years; if it started generating income before that date, the period extends to 40 years.

Read more: Publication 946 (2023), How To Depreciate Property

Monthly Depreciation Rates

Here are the monthly depreciation rates based on when the property becomes available for rent:

How to Calculate Depreciation on Rental Property

Calculating depreciation on rental property using the IRS’s Modified Accelerated Cost Recovery System (MACRS) is a straightforward process. 

Here’s how to do it step by step:

Step 1: Determine the Cost Basis of the Property

The cost basis of your property includes the purchase price, closing costs, and any improvements made, minus the value of the land. 

For example, if you bought a property for $1 million, incurred $20,000 in closing costs, and added a $4,000 deck while the land was valued at $60,000, your cost basis calculation would be:

1,000,000 + 20,000 + 4,000 − 60,000 = 964,000

Thus, your adjusted cost basis would be $964,000.

Closing Costs to Include

When calculating your cost basis, consider including the following closing costs and settlement fees:

• Abstract fees
• Legal fees
• Recording fees
• Transfer taxes
• Title insurance
• Surveys
• Utility installation fees
• Any amounts owed by the seller that you agree to pay (e.g., back taxes, interest, recording or mortgage fees)

Closing Costs to Exclude

Certain expenses cannot be included in your cost basis. These include:

• Fire insurance premiums
• Rent or charges related to occupancy before closing
• Fees related to obtaining or refinancing a loan (e.g., points, mortgage insurance premiums, loan assumption fees)
• Costs for credit reports and lender-required appraisals

Step 2: Calculate the Property's Depreciation Cost

To find the depreciation cost of your property, divide the adjusted cost basis by the recovery period. For residential rental properties, this period is 27.5 years. This method is known as straight-line depreciation and is the only method approved by the IRS for calculating property depreciation.

Alternatively, you can simplify this calculation by using the prescribed annual depreciation percentage of 3.636% for income properties. To find your annual depreciation expense, multiply your adjusted cost basis by this percentage.

For instance, if your property has a basis of $964,000:

964,000 × 0.03636 = 35,100 

You can claim this amount as a deduction on your annual tax return.

Calculating Depreciation for Year One: Special Considerations

If your property did not generate rental income for the entire first year, calculate depreciation based on the percentage corresponding to the month it began generating income. Refer to the “Monthly Depreciation Rates” section for guidance on determining this percentage.

Free Rental Property Depreciation Spreadsheet

To simplify the process of calculating depreciation on your rental property, we’ve created a free Rental Property Depreciation Spreadsheet to help you track depreciation expenses, calculate your annual depreciation deduction, and maximize your tax savings.

Why Use a Rental Property Depreciation Spreadsheet?

Our free rental property depreciation spreadsheet comes with a built in depreciation calculator. Quickly and easily calculate the annual depreciation rate for each property, track closing costs, work out your cost basis, and ultimately stay IRS compliant when depreciating your rental property.

How to Use the Rental Property Depreciation Spreadsheet

1. Download the free spreadsheet using the link below.
2. Enter your property details, including purchase price, land allocation, and month-in-service date.
3. Enter the closing costs such as, real estate commission, inspection fees, inspection surveys costs which affect the property cost basis.
4. View automatic calculations for your cost basis and yearly depreciation expenses.
5. Enter your annual depreciation amount into your accounting software to maximize deductions.

Download the free Rental Property Depreciation Spreadsheet

About Accelerated Depreciation for Rental Properties

Accelerated depreciation allows property owners to take larger depreciation deductions in the earlier years of ownership, reducing taxable income more quickly than standard straight-line depreciation. While residential rental properties must typically follow a 27.5-year straight-line schedule, certain components of a property may qualify for accelerated methods, such as bonus depreciation and Section 179 expensing.

Key Methods of Accelerated Depreciation

1. Cost Segregation – This strategy involves breaking down a property into individual components, such as appliances, flooring, or electrical systems, which may depreciate over 5, 7, or 15 years instead of 27.5 years. A cost segregation study identifies these assets, allowing for faster write-offs.
2. Bonus Depreciation – Under recent tax laws, landlords can deduct 100% of qualifying assets (such as furniture or landscaping improvements) in the first year of service rather than spreading costs over time. However, bonus depreciation is set to phase out gradually in the coming years.
3. Section 179 Deduction – Section 179 is not allowed on rental properties. This allows you to deduct the full cost of certain assets the year they are placed into service, rather than depreciating them over multiple years. However, eligibility rules and deduction limits apply. Specifically, to qualify for the Section 179 deduction, a property must be used in an active trade or business. Rental properties held solely for generating income, rather than as part of a trade or business, do not qualify. Similarly, investment properties and assets that produce royalties are also ineligible.

Benefits and Considerations

• Maximizes upfront tax savings – By claiming larger deductions earlier, property owners can free up cash flow for reinvestment.
• Reduces taxable income – Lower taxable income in the early years of ownership can help offset initial expenses.
• May trigger depreciation recapture – If the property is later sold, accelerated depreciation could increase taxable gains due to recapture rules.

Using accelerated depreciation effectively requires careful tax planning, but it can be a powerful tool for reducing tax liability and maximizing cash flow.

Related: What Is Accelerated Depreciation & How Can Landlords Use It For Tax Benefits?

How to Avoid Depreciation Recapture Tax on Rental Property?

If you own a rental property, you can typically deduct its annual depreciation cost from your taxable income. However, when you sell the property, the IRS may impose a recapture tax on the depreciation you've claimed. This tax is calculated based on the difference between the sale price and the property's depreciated value.

The depreciation recapture tax on your rental property is limited to 25% of the original depreciated value, depending on your ordinary income tax rate at the time of the sale. After the IRS collects the recapture tax, any remaining profit will be subject to capital gains tax. 

The good news is that you can avoid both depreciation recapture and capital gains taxes by utilizing a 1031 exchange. 

A 1031 exchange allows you to defer these taxes as long as you reinvest the proceeds from your sale into another rental property. To qualify for this deferral, you must continue your rental business and acquire a property that is considered "like-kind" to your previous one. 

Importantly, you have just 45 days after closing to identify up to three potential replacement properties. If you fail to designate a replacement within this timeframe, you will lose the opportunity to execute a 1031 Exchange.

Final Words: How to Calculate Depreciation on a Rental

A solid understanding of depreciation can help you reduce your overall tax liability, improve cash flow, and avoid surprises like depreciation recapture when selling your property.

The free rental property depreciation spreadsheet provided in this article can help you forecast your annual depreciation amount using straight-line depreciation. However, calculating depreciation can be complex especially if you want to use an accelerated depreciation schedule and front load those deductions. 

It’s also important to understand the recapture tax liabilities that apply when selling the property. As such, it’s always recommended to work with a tax professional to ensure that your depreciation schedule is not only accurate, but that it aligns with your long-term financial strategy. 

To simplify your depreciation tracking, you can leverage software like Landlord Studio which offers a recurring expense feature allowing you to automatically record your annual depreciation amounts for tax time, and our customizable financial reporting makes it easy to track the total depreciation claimed, and calculate estimated depreciation recapture. 

Create your free Landlord Studio account today and see how our award winning property management and accounting tools can help you save time and increase your portfolio ROI.

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