Real Estate Depreciation Rules for Investors
Discover how real estate depreciation works for investors. Learn key rules, benefits, and strategies to maximize your tax savings through property depreciation.
Investing in real estate offers a wide range of financial benefits—one of the most powerful being depreciation. For many investors, depreciation is a tax strategy that can significantly lower taxable income and boost overall returns.
In this article, we'll break down real estate depreciation rules in a simple and practical way so you can make the most out of your investment property.
What Is Real Estate Depreciation?
Real estate depreciation is the process of deducting the cost of buying and improving a rental property over its useful life. While your property may actually increase in market value, the IRS allows you to write off a portion of its cost each year as if it were losing value.
This tax deduction is only available for income-producing properties, such as rental homes, apartment buildings, and commercial real estate.
Why Depreciation Matters to Investors
Depreciation helps investors reduce their taxable income. That means you pay less in taxes, even if your property is making a profit.
Let’s say your rental property brings in $20,000 a year in net income. If depreciation allows you to deduct $7,000, then you’re only taxed on $13,000—not the full $20,000. This can lead to thousands of dollars in tax savings every year.
What Can Be Depreciated?
Not everything on your property can be depreciated. Here's what qualifies:
✅ Depreciable:
- The building or structure itself
- Improvements like a new roof or HVAC system
- Appliances, carpeting, or furniture (if used in the rental)
❌ Not Depreciable:
- Land (it doesn’t wear out)
- Landscaping
- Personal residence (depreciation is for rentals only)
How Long Can You Depreciate a Property?
The IRS assigns a “useful life” to different types of properties:
- Residential Rental Property: 27.5 years
- Commercial Property: 39 years
So if you buy a residential rental for $275,000 (not including land), you can deduct $10,000 each year over 27.5 years.
When Does Depreciation Start?
Depreciation begins when the property is placed in service—in other words, when it’s ready and available to be rented out, not necessarily when you buy it.
If you purchase a home in April but don’t rent it until August, you start depreciating in August. The first and last years of depreciation are prorated based on the number of months the property was in service.
Using the Modified Accelerated Cost Recovery System (MACRS)
The IRS requires investors to use MACRS, a depreciation system that spreads out the cost of your asset over its useful life.
There are two main types under MACRS:
- Straight-Line Depreciation (most common for real estate): Deducts the same amount each year.
- Accelerated Depreciation: Offers bigger deductions early on (used more for personal property, not buildings).
Cost Segregation: A Powerful Strategy
Want to accelerate your tax savings? Cost segregation can help.
This strategy separates personal property and land improvements from the main building. Items like carpets, lighting, and fences can be depreciated over shorter periods (5, 7, or 15 years), giving you larger upfront deductions.
It’s a more complex process and usually requires a professional study, but the tax benefits can be significant.
Depreciation Recapture: What to Know When You Sell
There’s a catch.
When you sell your property, the IRS may “recapture” the depreciation you claimed. This means you’ll pay a tax (up to 25%) on the depreciation deductions taken over the years.
Example: If you claimed $50,000 in depreciation and then sold the property, you could owe up to $12,500 in depreciation recapture tax.
The good news? You still come out ahead because the ongoing tax savings usually outweigh the recapture costs.
How to Calculate Depreciation
Here’s a quick example:
- Purchase price: $300,000
- Land value: $60,000 (not depreciable)
- Building value: $240,000
- Depreciation period: 27.5 years
Annual Depreciation = $240,000 ÷ 27.5 = $8,727.27
That’s your yearly deduction for as long as you own the property (or until 27.5 years is up).
What If You Forget to Depreciate?
Skipping depreciation doesn’t mean you can avoid depreciation recapture. The IRS assumes you took it—whether you did or not.
If you’ve missed out on claiming depreciation in the past, consult a tax professional. You may be able to file a form and catch up with what’s called a “catch-up depreciation” adjustment.
Tips for Real Estate Investors
Here are some quick tips to stay on top of depreciation rules:
- Keep detailed records of your property purchase, improvements, and rental use.
- Separate land from building value on your settlement statement or appraisal.
- Use tax software or a CPA to help calculate depreciation correctly.
- Re-evaluate depreciation annually if you make improvements or upgrades.
Conclusion
Depreciation is one of the most valuable tax tools available to real estate investors. It allows you to recover the cost of your property over time, lowering your taxable income and increasing your cash flow.
By understanding and applying these rules, you can keep more of your profits and build long-term wealth through smart investing.
Important Links
Step-by-Step Guide to Buying a House for the First Time
Best Places to Buy Rental Property for Cash Flow
How to Evaluate Property Value Before Buying