Understanding Depreciation of Rental Property: A Comprehensive Guide

Search Fintrev

Search our guides, reviews and glossary.

Depreciation of rental property is a tax deduction that lets a landlord recover the cost of a rental building gradually, over the period the tax code assigns to it, instead of deducting the purchase price in the year of the purchase. In the U.S., residential rental buildings, including single-family rentals, duplexes and apartment buildings, are generally depreciated over 27.5 years using the straight-line method under the Modified Accelerated Cost Recovery System (MACRS). Land is never depreciated. When you sell, the IRS taxes the depreciation you were allowed to take at a maximum rate of 25%. This applies even if you never claimed it.

How rental property depreciation works

Depreciation reflects the decline in an asset’s usefulness from wear and tear, age and obsolescence. For tax purposes it matches the cost of a building that produces income for decades to those years. Each year you deduct a slice of the building’s cost against your rental income, lowering your taxable rental profit without any cash leaving your account.

This holds even when the property’s market value is rising, which is mostly due to the land and location. The structure itself still ages, and the deduction is tied to your cost of the building, not to what the market says the property is worth.

What qualifies for depreciation

A rental property can be depreciated only if it meets all of these conditions:

1. You own it. Ownership counts even if the property is mortgaged. Tenants, lessees and property managers cannot depreciate a building they don’t own.
2. You use it to produce income. This means renting it out or using it in a business. A home you live in, or a vacation home used mainly for personal stays, doesn’t qualify unless it meets the rental-use rules. Mixed-use property is depreciated only for the rental portion.
3. It has a determinable useful life of more than one year. Buildings, structural components and equipment wear out. Land does not, so it is never depreciable.

A building counts as residential rental property when at least 80% of its gross rental income comes from dwelling units. Apartment buildings, condos and houses rented to long-term tenants fall into this category. Commercial buildings such as offices and retail space are nonresidential real property. That category uses a 39-year recovery period instead.

Depreciation also ends. It stops when you have recovered the full depreciable basis, or when you retire the property from service, whichever comes first. Selling it, converting it to personal use or abandoning it are all ways of retiring it.

MACRS: the method for residential rentals

MACRS is the required system for rental property placed in service after 1986. It has two versions. GDS applies unless you elect ADS or the law requires it. An ADS election for residential rental property is generally irrevocable once made.

General Depreciation System (GDS)

Under GDS, a residential rental building has a recovery period of 27.5 years, or 330 months. The building must use the straight-line method, so every full year produces the same deduction. That works out to about 3.636% of the depreciable basis per full year (1 ÷ 27.5).

The building itself cannot use accelerated depreciation, but other assets in the rental often can. Appliances, carpeting and furniture used in residential rental property are generally 5-year property under GDS. They can use the 200% declining balance method, which front-loads the deductions into the early years.

Alternative Depreciation System (ADS)

ADS stretches the recovery period for residential rental property to 30 years. Property placed in service before 2018 used 40 years. ADS uses the straight-line method for the building and for the assets inside it, so annual deductions are smaller than under GDS. ADS is required or commonly applies in situations such as:

• Property used predominantly outside the U.S.
• Tax-exempt use property
• Property financed with tax-exempt bonds
• Property used by foreign persons or entities not subject to U.S. income tax
• Certain real estate businesses that elect out of the business interest deduction limit

Recovery periods at a glance

Calculating your rental property depreciation

Step 1: Find the depreciable basis

Start with the cost basis, which is the purchase price plus certain settlement costs. These include legal fees, recording fees, transfer taxes, title insurance, surveys and amounts you agreed to pay on the seller’s behalf, such as back taxes. Costs tied to getting a mortgage are not added to the property’s basis. Capital improvements made before the property is placed in service are added.

Then subtract the land value. You can allocate the purchase price based on fair market values at purchase. One method is to apply the ratio from your local property tax assessment, which splits value between land and improvements. An appraisal is another option. The amount assigned to the building is the depreciable basis.

Step 2: Divide by the recovery period

Annual depreciation = depreciable basis ÷ 27.5 (GDS). Divide by 12 for the monthly figure.

Step 3: Apply the mid-month convention

Residential rental property is treated as placed in service in the middle of the month it is ready and available for rent, whatever the actual date. The first year therefore gets half a month for the starting month plus the full months after it. The final year picks up whatever remains of the 330 months.

Worked example (hypothetical)

Assume a rental house with these figures:

• Purchase price: $250,000
• Settlement costs added to basis: $5,000
• Improvements before renting: $10,000
• Total cost basis: $265,000
• Land value: $70,000
• Depreciable basis: $195,000

Full-year depreciation is $195,000 ÷ 27.5 = $7,090.91, or about $590.91 per month.

Assume the house is placed in service in April. Under the mid-month convention, year one covers half of April plus May through December, which is 8.5 months. Years 2 through 27 are full years. Those 320.5 months used leave 9.5 months for year 28.

The MACRS percentage tables in IRS Publication 527 and Publication 946 produce the same results. Many tax programs apply them automatically once you enter the basis and the in-service month.

Improvements vs. repairs

A repair keeps the property in ordinary operating condition. Fixing a leak, patching drywall and repainting between tenants are repairs. They are deducted in full in the year you pay for them.

An improvement adds value, extends the property’s life or adapts it to a new use. It is capitalized and depreciated as its own asset, starting when it is placed in service. Examples include a new roof, a full kitchen remodel, a replacement HVAC system or an added room. A new roof on a rental house gets its own 27.5-year schedule beginning the month it is installed, separate from the original building. New appliances for the unit follow the 5-year schedule.

Lumping improvements into repairs overstates the current-year deduction. Treating repairs as improvements does the opposite and delays deductions you could take now.

Reporting depreciation on your tax return

Individual landlords report rental income, expenses and depreciation on Schedule E, which flows to Form 1040. Form 4562 is required in the year you place the property or any new improvement in service. After that, the deduction appears on Schedule E. If you own rentals through a partnership or multi-member LLC, depreciation is taken at the entity level, and your share arrives on a Schedule K-1.

Depreciation can turn a property with positive cash flow into a tax loss. Rental losses are generally passive. Under the passive activity rules, individuals who actively participate in a rental can deduct up to $25,000 of rental losses against other income. That allowance phases out between $100,000 and $150,000 of modified adjusted gross income. Losses you can’t use are carried forward to later years or to the year you sell.

Keep the closing statement, the land allocation, invoices for each improvement and a running depreciation schedule for as long as you own the property and for several years after you sell. Your adjusted basis depends on all of them.

Depreciation recapture when you sell

Each dollar of depreciation lowers your adjusted basis, which increases your taxable gain when you sell. The portion of gain caused by depreciation on the building is called unrecaptured Section 1250 gain. It is taxed at your ordinary income rate, capped at 25%. The rest of a long-term gain is taxed at the regular long-term capital gains rates of 0%, 15% or 20%.

Recapture is based on depreciation that was allowed or allowable. If you were entitled to the deduction and skipped it, your basis is still reduced as if you had taken it. You owe the recapture tax without ever having received the deduction.

Recapture example (hypothetical)

Assume these figures, ignoring selling costs:

• You buy a rental for $200,000: $160,000 for the building and $40,000 for the land.
• Over 8 full years you claim $160,000 ÷ 27.5 × 8 = $46,545 of depreciation.
• Your adjusted basis becomes $200,000 − $46,545 = $153,455.
• You sell for $250,000, for a total gain of $96,545.

The tax splits into two parts:

• $46,545 is unrecaptured Section 1250 gain, taxed at no more than 25%. The maximum tax on this portion is $11,636.
• $50,000 is the remaining gain, taxed at your long-term capital gains rate.

Recapture can be deferred, not erased, through a like-kind (Section 1031) exchange into another investment property. Heirs who inherit a rental generally receive a stepped-up basis, which eliminates the built-up gain, including the depreciation portion. The home-sale exclusion for a primary residence does not shelter depreciation taken after May 6, 1997. This matters if you rented out a home you later moved into.

Common mistakes

• Depreciating the land. Including land value in the basis overstates every year’s deduction and the error compounds over 27.5 years.
• Starting on the purchase date. Depreciation begins when the property is ready and available for rent. A house bought in January but not rentable until May starts in May.
• Mixing repairs and improvements. Each improvement needs its own schedule and in-service date.
• Skipping depreciation entirely. If you missed it in past years, you can generally correct the error by amending returns or filing Form 3115 for a change in accounting method. The right route depends on how many years were missed.

FAQs

The Bottom Line

Landlords who own residential rentals should claim depreciation every year, starting from the month the property is ready for rent. The IRS reduces your basis whether or not you take the deduction, so skipping it only raises your future tax. Track the land allocation, each improvement and a running schedule, and plan for recapture at sale or defer it through a Section 1031 exchange.