You bought a rental. Now you want your money back. Not just from the rent, but from the IRS. Honestly, the tax code is usually a nightmare, but how to depreciate property is one of the few areas where the government actually lets you keep your cash. It’s basically a "phantom expense." You aren't writing a check to anyone, but your taxable income drops anyway.
It feels like a cheat code. But if you mess up the math, the IRS will come knocking for "recapture" taxes later.
Most people think depreciation is just about the building getting old. Sure, that’s part of it. But really, it’s an accounting method to recover the cost of an income-producing asset over its "useful life." For residential stuff, that’s 27.5 years. For commercial? 39 years. Why those specific numbers? Because Congress said so. There’s no deep scientific reason why a house "expires" in exactly 27 and a half years.
The Land Problem Everyone Forgets
Here is the first big mistake. You cannot depreciate land. Dirt doesn't wear out. It doesn't rot. It just sits there.
If you bought a property for $500,000, you can't just start depreciating that whole half-million. You have to split the value between the building and the land. If the land is worth $100,000, your depreciable basis is only $400,000. Use the property tax assessor’s breakdown or get a professional appraisal. Seriously. If you guess and the land-to-building ratio looks weird, you’re asking for an audit.
How to Depreciate Property Using MACRS
The IRS uses the Modified Accelerated Cost Recovery System (MACRS). It sounds like a 90s action movie title, but it’s just the framework for timing your deductions. For most residential real estate, we use the GDS (General Depreciation System). This uses a "straight-line" method.
Essentially, you take your cost basis (minus the land), divide it by 27.5, and that’s your annual deduction.
Let’s look at a real-world scenario. Say you buy a duplex in Little Rock for $300,000. The city says the land is worth $30,000. Your basis is $270,000.
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$$\frac{270,000}{27.5} = 9,818.18$$
That’s $9,818 you get to subtract from your rental income every single year. If your property profited $10,000, you only pay taxes on about $182. That is the power of real estate.
The Mid-Month Convention
You don't get a full year of depreciation if you buy the place in December. The IRS uses a "mid-month convention." This means no matter when you closed during the month, the IRS treats it as if you bought it right in the middle. If you close on January 2nd or January 30th, you get 11.5 months of depreciation for that first year.
It’s a small detail. But it matters when you’re trying to be precise.
Cost Segregation: The Turbo Button
Straight-line depreciation is slow. It’s fine for a casual landlord, but serious investors want their money now. This is where cost segregation comes in.
Instead of treating the whole house as one 27.5-year lump, you break it down into pieces.
- 5-year property: Carpeting, appliances, furniture.
- 7-year property: Office furniture or specialized equipment.
- 15-year property: Fences, sidewalks, shrubbery (land improvements).
By doing a cost segregation study, you might move 20% to 30% of the building's value into these shorter-lived categories. This front-loads your deductions. You get a massive tax break in the first few years, which you can reinvest into more property. Companies like KBKG or engineered tax services specialize in this. It isn't cheap—it might cost a few thousand dollars—but if it saves you $50,000 in taxes this year, the ROI is obvious.
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Bonus Depreciation is Fading
We have to talk about the Tax Cuts and Jobs Act of 2017. It introduced 100% bonus depreciation, which allowed you to write off the entire cost of 5, 7, and 15-year items in year one.
But it's sunsetting.
In 2023, it dropped to 80%. In 2024, it’s 60%. By 2026, it will be 20% unless Congress changes the law. You can still use it, but the "instant write-off" glory days are ending. You have to plan for a smaller immediate impact and a longer recovery period.
The IRS "Recapture" Trap
Depreciation isn't a free gift. It’s a loan from the government.
When you sell the property, the IRS wants their pound of flesh. This is called Depreciation Recapture. They look at all the depreciation you should have taken (even if you didn't actually claim it!) and tax it at a rate of up to 25%.
If you took $100,000 in depreciation over ten years and sell for a profit, you owe taxes on that $100,000 at the recapture rate. This catches people off guard. They see a big check at closing and forget that the IRS is waiting in the wings.
The only real way around this is a 1031 Exchange.
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Section 1031 of the Internal Revenue Code allows you to roll your profits—and your depreciation—into a new, "like-kind" investment property. You defer the taxes. You keep doing this until you die. Then, your heirs get a "step-up in basis," and the accumulated depreciation disappears. It is the ultimate wealth-building strategy.
What Qualifies for Depreciation?
You can’t just depreciate your personal home. Sorry.
To start the clock, you must meet four criteria:
- You own the property (even if it has a mortgage).
- You use it in your business or income-producing activity.
- It has a determinable useful life (it must wear out eventually).
- It is expected to last more than one year.
You stop depreciating when you have recovered your entire cost basis or when you retire the property from service—meaning you sell it, it gets destroyed, or you move into it yourself.
Improvements vs. Repairs
This is a huge point of contention.
If you fix a broken toilet, that’s a repair. You deduct the full cost this year.
If you replace the entire plumbing system, that’s an improvement. You have to depreciate that over 27.5 years.
The IRS uses the "BAR" test to decide:
- Betterment: Does it fix a defect or expand the property?
- Adaptation: Are you changing the use (e.g., turning a garage into a bedroom)?
- Restoration: Did you replace a major structural component?
If the answer is yes, you can't deduct it all at once. You’re stuck with the long-term depreciation schedule.
Actionable Next Steps for Property Owners
Don't just read this and sit on it. Taxes are won in the planning phase, not when you're filing in April.
- Audit your HUD-1 statement. Look at your closing costs from when you bought the property. Some costs, like legal fees and recording fees, get added to your basis. Others, like fire insurance premiums, do not.
- Determine your Land-to-Building ratio. Check your local assessor's website. If they say your land is 50% of the value but similar plots are selling for much less, get a formal appraisal to justify a higher building basis.
- Decide on Cost Segregation. If your property is worth over $500,000 (excluding land), call a cost seg specialist. Ask for a free "pro-forma" to see if the tax savings outweigh their fee.
- Track every "Capital Improvement." Keep a folder for roofs, HVAC units, and windows. These aren't simple repairs; they are additions to your basis that must be tracked separately on your Form 4562.
- Consult a CPA who actually owns real estate. Most accountants are great at data entry, but few understand the nuance of real estate professional status (REPS) or short-term rental loopholes that allow you to use depreciation to offset W-2 income.
Depreciation is a tool. It's boring, technical, and full of math, but it is the primary reason real estate creates more millionaires than almost any other asset class. Use it, but respect the rules, because the IRS has a very long memory.