📊 Rental Property Depreciation

Depreciation is typically the largest single tax benefit available to rental property owners. It allows you to deduct the cost of your building over time — reducing taxable rental income each year without spending any additional cash. Understanding how it works, and how to maximize it, is one of the most valuable financial skills a landlord can develop.

▶ Video Overview

How Depreciation Works

The IRS allows landlords to deduct the cost of rental property over its “useful life” — even though the property may actually be appreciating in value. The theory is that the building wears out over time, so the cost should be recovered through annual deductions.

Key rules for residential rental property:

• 27.5-year straight-line depreciation — the building’s cost is divided equally over 27.5 years
• Land is not depreciable — only the building and improvements; you must allocate purchase price between land and building
• Starts when the property is placed in service — when it’s available for rent, not necessarily when a tenant moves in
• Mid-month convention — the first and last year use a mid-month calculation regardless of when in the month you acquired or sold

Calculating Your Annual Depreciation

The basic calculation:

1. Determine your cost basis: purchase price + closing costs + improvements, minus the value allocated to land
2. Divide by 27.5 to get your annual depreciation deduction

Example: You buy a rental for $350,000. The land is worth $70,000 (20%). Building basis = $280,000. Annual depreciation = $280,000 ÷ 27.5 = $10,182 per year — a non-cash deduction reducing your taxable rental income every year.

Cost Segregation — Accelerating Depreciation

Cost segregation is an engineering and tax analysis that reclassifies components of the building into shorter depreciation periods — 5, 7, or 15 years — rather than the full 27.5 years. This dramatically accelerates deductions into earlier years.

Components that may qualify for shorter lives:

• Carpeting, flooring — 5 years
• Appliances, cabinets — 5 years
• Certain plumbing fixtures — 5 years
• Landscaping, parking lots, fencing — 15 years
• Land improvements — 15 years

Cost segregation studies typically cost $5,000–$15,000 but can generate tens of thousands in accelerated deductions. Generally worth it for properties over $500,000 in value.

Bonus Depreciation

Under recent tax law (Tax Cuts and Jobs Act and subsequent legislation), certain property components qualifying for shorter depreciation periods may also qualify for bonus depreciation — allowing you to deduct a significant percentage of the cost in the first year. The bonus depreciation percentage phases down over time. Your CPA can identify which components of your property qualify.

Depreciation Recapture at Sale

When you sell a rental property, the IRS “recaptures” the depreciation you’ve taken — taxing it at up to 25% (the Section 1250 recapture rate), separate from capital gains rates. This is an important consideration in exit planning:

• If you’ve taken $100,000 in depreciation over 10 years and sell, that $100,000 is taxed at up to 25% — a $25,000 tax bill just on recapture
• A 1031 exchange allows you to defer both capital gains and depreciation recapture by rolling proceeds into a like-kind property
• Holding until death can eliminate recapture through the step-up in basis rule (consult an estate planning attorney)