How To Calculate Depreciation on Rental Property

Key Takeaways

• Depreciation deducts a residential rental's building cost over 27.5 years.
• Only the building depreciates: land does not.
• It shelters rental income from tax, boosting your after-tax return.
• Depreciation is 'recaptured' and taxed when you sell.

What is rental property depreciation?

Depreciation^[1] is one of real estate's most valuable, and most misunderstood, tax benefits. The IRS^[2] lets you treat a rental building as an asset that wears out over time, deducting a portion of its cost each year as an expense. Crucially, this is a *paper* expense: you don't spend any cash, yet it reduces your taxable rental income, lowering your tax bill while the property may actually be rising in value.

That combination, a deduction without an outlay, is what makes depreciation so powerful. A rental can generate positive cash flow yet show a small taxable loss on paper once depreciation is applied, meaning you keep more of the rent you collect. Over a long hold, the cumulative tax savings can add up to a substantial part of your total return. Model a property's after-tax picture with the Rental Property Calculator.

Depreciation applies to property held to produce income, like a rental, not to your personal residence. It begins when the property is placed in service (ready and available to rent) and continues until you've deducted the full depreciable basis or sell the property. The sections below explain the schedule, what portion of your purchase actually depreciates, and the catch that arrives when you sell.

How depreciation works: the 27.5-year schedule

For residential rental property, the IRS uses a recovery period of 27.5 years, applying the straight-line method, meaning you deduct an equal amount each year. To find the annual deduction, you divide the building's depreciable basis by 27.5. (Commercial property uses a longer 39-year period, but most individual investors deal with residential rentals.)

Here's the basic mechanics with round numbers. If a rental's depreciable basis, the building portion, as the next section explains, is $275,000, your annual depreciation deduction is $275,000 ÷ 27.5 = $10,000 a year. You claim that $10,000 as an expense on your tax return every year for 27.5 years, steadily offsetting your rental income even though no cash leaves your pocket.

Because the deduction is the same each year under the straight-line method, depreciation is predictable and easy to plan around. The first and last years are prorated based on when the property entered and left service, but the middle years are simply the basis divided by 27.5. That steady, dependable deduction is part of what makes rental real estate so tax-efficient compared with many other investments.

Land vs. building: only the building depreciates

A critical rule trips up many new investors: land does not depreciate: only the building does. The logic is that buildings wear out over time while land does not, so the IRS only lets you depreciate the structure and improvements, never the dirt underneath. This means you can't simply depreciate your entire purchase price; you first have to split it between land and building.

Suppose you buy a rental for $300,000. If a reasonable allocation, often based on the local tax assessor's land-to-improvement ratio, assigns 20% to land and 80% to the building, then $60,000 is land (non-depreciable) and $240,000 is the building. Your depreciable basis is $240,000, giving an annual deduction of $240,000 ÷ 27.5 = about $8,727. Getting this allocation right matters: assign too much to land and you under-deduct; too much to the building and you risk an audit issue.

Your depreciable basis also includes certain closing costs and the cost of capital improvements you make over time (a new roof or addition), each depreciated on its own schedule. Major improvements add to basis and depreciation; routine repairs are deducted immediately instead. Because these distinctions affect your taxes for decades, many investors work with a tax professional to set the allocation and basis correctly from the start.

How depreciation saves you money

The value of depreciation is that it shelters rental income from tax. Imagine a rental that nets $9,000 in cash flow for the year. Without depreciation, you'd owe income tax on much of that. But if your depreciation deduction is $8,727, your *taxable* rental income shrinks to roughly $273, even though you still collected and kept the $9,000 in cash. You've legally converted most of your taxable income into tax-free cash flow.

The dollar value of that shelter depends on your tax bracket. An $8,727 deduction is worth $8,727 times your marginal tax rate, about $2,094 in tax savings at a 24% rate, every year. That's a meaningful boost to your after-tax return that doesn't depend on the property performing any better; it's simply a feature of how rental real estate is taxed. Over a decade, the cumulative savings can rival a full year's rent.

In some cases depreciation can even create a 'paper loss,' taxable income below zero, that may offset other income, subject to IRS passive-activity rules and income limits. Those rules are nuanced and worth reviewing with a professional, but the headline is simple: depreciation is a powerful, cash-free deduction that makes rental property more tax-efficient than its raw cash flow suggests.

Depreciation recapture when you sell

There's a catch worth planning for: depreciation recapture. The deductions you took aren't entirely free forever, when you sell, the IRS 'recaptures' the depreciation you claimed and taxes it, currently at a maximum rate of 25%. In effect, depreciation defers tax and converts some of it to a different rate, rather than eliminating it outright.

An example shows the mechanics. If you depreciated $80,000 over your years of ownership and then sell, that $80,000 is subject to recapture tax. The rest of your gain (from appreciation above your original basis) is taxed as a capital gain. Knowing recapture is coming helps you avoid an unpleasant surprise at closing and plan the sale accordingly.

Many investors defer recapture and capital-gains tax entirely using a 1031 like-kind exchange, rolling the proceeds into another investment property. Others simply factor the recapture into their projected after-tax return on sale. Either way, the right takeaway isn't to avoid depreciation, you must claim it, and the IRS assumes you did whether you took it or not, but to understand that it's a powerful deferral whose bill partly comes due at sale.

Common mistakes

The most damaging mistake is not taking depreciation at all, or taking it incorrectly. The IRS calculates recapture based on the depreciation you were *allowed* to take, not just what you actually claimed, so skipping it means you'll owe recapture tax on deductions you never benefited from. If you own a rental, you should be depreciating it, full stop.

Another frequent error is depreciating the land or botching the land-to-building split. Depreciating your entire purchase price overstates your deductions and invites trouble; under-allocating to the building leaves money on the table. Use a defensible basis for the split, commonly the assessor's ratio or an appraisal, and document it. Likewise, confusing repairs (deducted now) with improvements (added to basis and depreciated) is a common slip-up.

Finally, many investors forget about recapture until they sell and are caught off guard by the tax bill. Build the eventual recapture into your return projections from the beginning, and consider strategies like a 1031 exchange if you plan to keep reinvesting. Because depreciation rules are detailed and the stakes span decades, this is one area where a qualified tax professional usually pays for themselves.

Frequently Asked Questions

How long do you depreciate a rental property?

Residential rental property is depreciated over 27.5 years using the straight-line method. Commercial property uses 39 years.

Can you depreciate the land under a rental?

No. Only the building and improvements depreciate, because land doesn't wear out. You must split your purchase price between land and building first.

How much can I deduct in depreciation each year?

Divide the building's depreciable basis by 27.5. For example, a $240,000 building basis gives about $8,727 a year in depreciation deductions.

What is depreciation recapture?

When you sell, the IRS taxes the depreciation you claimed (or were allowed to claim), currently up to 25%. It effectively defers tax rather than eliminating it.

Do I have to take depreciation on my rental?

You should: the IRS bases recapture on the depreciation you were allowed to take, so skipping it means owing tax on deductions you never used. A tax professional can help.