Depreciation

What is depreciation?

Depreciation is the tax code’s recognition that buildings wear out. Owners of residential rental property deduct the cost of the structure (not the land) in equal parts over 27.5 years, about 3.64% of the building’s basis per year, against rental income. Commercial buildings use 39 years. The deduction requires no cash outlay, which is why rentals often produce positive cash flow alongside a paper loss.

This is the heart of real estate’s tax advantage. A property generating $5,000 of annual cash flow with a $7,000 depreciation deduction reports a $2,000 taxable loss, the owner pockets cash while owing no current income tax on it, and the loss may offset other passive income (or, for qualifying cases, other income under the passive activity rules).

Depreciation is a deferral, not a gift. Every dollar deducted reduces the property’s cost basis, and on sale the IRS "recaptures" the benefit by taxing accumulated depreciation at up to 25%. Investors manage this with 1031 exchanges (deferring both gains and recapture), holding until death (basis step-up), or simply accepting recapture as the cost of decades of tax-deferred cash flow. Depreciation is not optional in effect: recapture is computed on depreciation "allowed or allowable," so failing to claim it only forfeits the benefit.

Worked example

You buy a rental for $250,000, with the county assessing land at 20% of value. Building basis = $200,000; annual depreciation = $200,000 ÷ 27.5 = $7,273. If the property produced $6,000 of cash flow after all expenses, taxable income is negative on paper despite money in your pocket.

Frequently asked questions

Can I depreciate the land my rental sits on?

No. Land does not wear out in the eyes of the tax code, so only the building and improvements are depreciable. Owners split the purchase price between land and structure, commonly using the county assessor’s ratio or an appraisal. In expensive coastal markets land can be 40%+ of value, which meaningfully shrinks the deduction compared with the same-priced property in a low-land-cost market.

What happens to depreciation when I sell?

Accumulated depreciation is "recaptured": the portion of your gain attributable to depreciation deductions is taxed at your ordinary rate up to a 25% maximum, separate from the capital gains rate on the rest. A 1031 exchange defers both taxes; inheriting heirs receive a stepped-up basis that erases the deferred liability. Because recapture applies to depreciation allowed or allowable, you owe it even on deductions you neglected to claim.

Does depreciation apply to my primary residence?

No, depreciation only applies to property used in a trade or business or held for the production of income, such as rentals and home offices. If you convert your home into a rental, depreciation begins at conversion using the lesser of your adjusted basis or the fair market value at that time.

Related tools and guides

• Rental Property Depreciation Guide
• 1031 Exchange Calculator