How to Calculate Depreciation on a Rental Property

What Rental Property Depreciation Is

Depreciation is a tax deduction that lets you recover the cost of a rental building over time. The IRS treats a rental structure as an asset that wears out, so you can deduct a portion of its value each year even though you paid for it once and even if the property is rising in market value.

Only the building depreciates. Land does not wear out, so its value is excluded from the calculation. Depreciation is a paper expense: it reduces taxable rental income without costing you cash that year, which is why it is one of the most valuable tax benefits of owning rentals.

The Depreciation Formula

Residential rental property is depreciated using the straight-line method over 27.5 years. You take the depreciable basis, which is the cost basis minus the value of the land, and divide it by 27.5 to get the same deduction every full year.

Commercial property uses a 39-year schedule instead of 27.5 years, but for single-family homes, condos, and small multifamily rentals, 27.5 years is the number you will use. The result is the amount you can deduct against rental income each year the property is in service.

Step 1: Determine Your Cost Basis

Cost basis is more than the purchase price. It includes the price you paid plus most closing costs that are not loan charges, such as title fees, recording fees, transfer taxes, and legal costs. Capital improvements made before placing the property in service are added to the basis as well.

Some costs are not part of basis. Loan-related fees, prepaid insurance, and prepaid property taxes are handled separately. Getting basis right matters because it is the starting point for every future depreciation figure and for your gain calculation when you sell.

Step 2: Separate Land From Building

Because land does not depreciate, you must split your cost basis between land and the building. A common approach is to use the ratio shown on your county property tax assessment. If the assessment values the land at 20% and the improvements at 80% of the total, you apply that 80% to your cost basis to get the depreciable building value.

An appraisal can also be used to allocate value, and it is often more favorable in areas where assessed land values are unusually high. Whatever method you choose, keep documentation, because the land-to-building split directly changes your annual deduction.

Step 3: Apply the 27.5-Year Schedule

Once you know the depreciable basis, divide by 27.5 for the annual deduction. Suppose you buy a rental for $300,000, closing costs add $8,000, and your assessment shows land is 20% of value. Your cost basis is $308,000, land is about $61,600, and the depreciable basis is roughly $246,400.

Dividing $246,400 by 27.5 gives about $8,960 per year in depreciation. That deduction offsets rental income, so if the property nets $9,000 in taxable profit before depreciation, this deduction can wipe out most of the tax on that income for the year.

The Mid-Month Convention

The IRS uses a mid-month convention for residential rental property. This means the first year is prorated based on the month the property was placed in service, treated as if it started at the midpoint of that month, and the final year is prorated the same way.

For example, if you place a property in service in April, you get roughly 8.5 months of depreciation in year one rather than a full year. Every full calendar year after that receives the complete annual amount until the property is fully depreciated or sold.

What Can and Cannot Be Depreciated

• Depreciable: the building itself, and capital improvements such as a new roof, HVAC system, or addition, each on its own schedule.
• Depreciable separately: appliances, carpet, and some fixtures may qualify for shorter 5 to 15 year schedules under cost segregation.
• Not depreciable: land, landscaping considered part of the land, and the property while it is your personal residence.
• Not depreciated: routine repairs such as painting or fixing a leak, which are deducted in full the year they occur instead.

Depreciation Recapture at Sale

Depreciation is not free money. When you sell, the IRS recaptures the depreciation you claimed, or were allowed to claim, and taxes it at a rate of up to 25%. This is why you should always take depreciation: the IRS assumes you did whether or not you actually deducted it.

A 1031 exchange can defer both capital gains and depreciation recapture by rolling proceeds into another investment property. Because recapture and basis rules get complicated at sale, this is the stage where working with a tax professional pays for itself.

Frequently Asked Questions