Depreciation (Rental Property)
The annual tax deduction that allows rental property owners to write off the cost of the building over 27.5 years.
Definition
Depreciation is the largest and most misunderstood tax benefit in rental property investing. The IRS treats residential rental buildings as assets with a 27.5 year useful life, which means you can deduct 1/27.5th of the building's cost basis each year against your rental income, even though the building is probably actually appreciating. Only the building depreciates, not the land, so you have to allocate the purchase price between building and land (tax assessor ratios are the most common method). On a $200,000 property with a $160,000 building basis, you deduct roughly $5,818 per year in depreciation for 27.5 years. That deduction can offset rental income dollar for dollar on Schedule E, and in many cases it can generate a paper loss that offsets other income. Depreciation does not produce cash in your pocket directly, but it reduces your tax bill, which is the same thing. The catch is depreciation recapture at sale: the IRS takes back up to 25% of the depreciation you claimed when you sell, unless you do a 1031 exchange.
Formula
Example
Purchase price $220,000. Land value allocated 18% = $39,600. Building basis = $180,400. Annual depreciation = 180,400 / 27.5 = $6,560 deducted every year on Schedule E.
Frequently asked
How long do I depreciate a rental property?
Residential rentals depreciate over 27.5 years. Commercial properties depreciate over 39 years.
Can I depreciate the land?
No. Land does not depreciate. Only the building portion of your cost basis is depreciable.
Do I have to take depreciation on my rental?
Yes in practice. Even if you do not claim it, the IRS calculates depreciation recapture at sale as if you did, so failing to take it is a pure loss.
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