What depreciation means and why it matters on your taxes

Depreciation is a tax deduction that lets you reduce your taxable rental income each year by spreading the cost of your building over its useful life. The IRS assumes buildings wear out over time, so it lets you deduct a portion of what you paid for the structure (not the land) annually. This deduction lowers the income you report on your tax return, which can reduce what you owe.

You cannot deduct the full purchase price in the year you buy the property. Instead, you divide the building's cost by the number of years the IRS says it will last, and deduct that amount each year. For residential rental property, that period is 27.5 years. For commercial property, it is 39 years. The land itself never depreciates—only the building and its components.

Depreciation is a "paper loss" because you are not actually spending money each year. You already spent it when you bought the property. But the IRS treats it as a deductible expense, which means you can lower your taxable income without a cash outflow. This is one reason rental property ownership can produce tax benefits even when the property generates positive cash flow.

Key Takeaways

  • Residential rental buildings depreciate over 27.5 years; you divide the building cost (not land value) by 27.5 to find your annual deduction.
  • You must separate the land value from the building value using your purchase documents, a professional appraisal, or the county assessor's records.
  • Depreciation begins the year the property is placed in service (ready to rent), not the year you buy it.
  • You report depreciation on Form 4562 and carry the deduction to Schedule E (rental income and loss).
  • When you sell the property, the IRS recaptures depreciation you claimed and taxes it at a higher rate, so depreciation is not a permanent tax break.

Separating the building cost from the land value

The first step is figuring out how much of your purchase price was the building and how much was the land. The IRS will not let you depreciate land, so this number must be accurate. You have three main ways to find it.

Your purchase documents: Look at your closing statement or deed. Some sellers or title companies break out the land and building values. If yours does, use that figure. If not, move to the next method.

County assessor records: Your county assessor assigns a land value and a building value for property tax purposes. Call your county assessor's office or visit their website (usually searchable by address) and ask for the assessed values. These are not market values, but they give you a ratio you can explore to your purchase price. For example, if the assessor says land is 20 percent and building is 80 percent of total value, explore that same split to what you paid.

Professional appraisal: If the assessor's records are missing or unreliable, hire a real estate appraiser to separate land and building value. This costs $300 to $600 but creates a defensible record if the IRS questions your depreciation later. Keep the appraisal with your tax records.

The basic depreciation formula

Once you know the building value, the math is straightforward. For residential rental property:

Annual depreciation = Building cost ÷ 27.5 years

Example: You buy a rental house for $300,000. The land is worth $75,000 (based on the assessor's records), so the building is worth $225,000. Your annual depreciation is $225,000 ÷ 27.5 = $8,181.82 per year.

You claim this deduction every year you own the property and it remains in service as a rental. If you own it for 10 years, you deduct $8,181.82 each year for 10 years. After 27.5 years, the building is fully depreciated and you stop claiming the deduction (though you can still own and rent the property).

For commercial property, the formula is the same but the useful life is 39 years instead of 27.5, so your annual deduction is smaller.

When depreciation starts and stops

Depreciation begins the year the property is placed in service—meaning it is ready and available to rent. If you buy a property in March and it is ready to rent in May, you start depreciating in the year you bought it, not the following year. If you buy it in December but do not finish repairs until February of the next year, depreciation starts in the year you finish repairs.

If you buy the property but do not rent it out (you live in it yourself, or you hold it vacant as an investment), you cannot claim depreciation. The property must be held for the production of income. Once you convert it to a rental, depreciation begins.

Depreciation stops when you sell the property or convert it to personal use. If you sell in June, you claim a partial year of depreciation (six months' worth) in the year of sale. If you move into the property and stop renting it, you stop claiming depreciation that year.

Bonus depreciation and cost segregation

In some years, the IRS allows bonus depreciation, which lets you deduct a larger portion of the building cost in the first year instead of spreading it over 27.5 years. Bonus depreciation rules change frequently based on tax law, so check the current year's rules or ask a tax professional whether you may have access to.

Cost segregation is a more advanced strategy where you hire an engineer and accountant to break down the building into components (roof, flooring, fixtures, landscaping) and assign each a different useful life. Some components depreciate faster than the building itself, which accelerates your deductions in early years. Cost segregation requires a professional study and is most useful for large commercial properties where the tax savings justify the $5,000 to $15,000 cost of the study.

For a typical residential rental property, cost segregation is usually not worth the cost. For larger or commercial properties, it can produce significant tax savings. Discuss it with a tax professional who works with rental property owners.

Reporting depreciation on your tax return

You report depreciation on Form 4562 (Depreciation and Amortization), which you file with your federal tax return. On Form 4562, you list the property address, the date you placed it in service, the cost basis (the building value), the useful life (27.5 or 39 years), and the depreciation method (almost always straight-line for rental property).

The annual depreciation amount then carries to Schedule E (Supplemental Income and Loss), which is where you report all rental income and expenses. Schedule E is part of your Form 1040 (individual income tax return). The depreciation deduction reduces your net rental income, which lowers your overall taxable income.

Keep records of how you calculated the building value, the date the property was placed in service, and the depreciation amount each year. If you use tax software, it usually has a rental property module that walks you through these fields. If you use a tax professional, provide them with the building value and the date placed in service, and they will handle the forms.

Depreciation recapture when you sell

When you sell the rental property, the IRS recaptures the depreciation you claimed. This means the gain on the sale is taxed in two parts: the gain from appreciation (the difference between what you paid and what you sold for) and the depreciation you deducted.

Depreciation recapture is taxed at 25 percent, which is higher than the long-term capital gains rate (15 or 20 percent, depending on income). This means depreciation is not a permanent tax break—you are deferring tax, not avoiding it. You pay it back when you sell.

Example: You bought the house for $300,000 and sold it for $450,000 after 10 years. You claimed $81,818 in total depreciation ($8,181.82 × 10 years). Your total gain is $150,000. Of that, $81,818 is recaptured depreciation (taxed at 25 percent) and $68,182 is appreciation (taxed at the capital gains rate). This is why depreciation is useful for reducing income in years you own the property, but it does not eliminate tax when you sell.

Frequently Asked Questions

Can I claim depreciation on a property I just bought but have not rented yet?

No. Depreciation starts only when the property is placed in service—meaning it is ready and available to rent. If you are still renovating or waiting for a tenant, you cannot claim depreciation yet. Once it is ready to rent, depreciation begins that year, even if you have not found a tenant.

What if I inherited a rental property—when does depreciation start?

Depreciation starts the year after you inherit it, based on the fair market value of the building on the date of death (not what the previous owner paid). You get a "stepped-up basis," which means you use the value on the inheritance date, not the original purchase price. This is a significant tax benefit of inherited property.

Do I have to claim depreciation every year?

You should claim it every year you own a rental property. If you do not claim it in a year, the IRS still considers it claimed for recapture purposes when you sell. You cannot avoid recapture by skipping the deduction. Claiming it reduces your current taxable income, so there is no reason not to.

Can I depreciate improvements I make to the property after I buy it?

Yes. If you add a new roof, replace the HVAC system, or build an addition, those costs can be depreciated over 27.5 years (for residential property) starting the year the improvement is placed in service. Keep receipts and separate these costs from repairs, which are deductible in full in the year you pay for them.

What happens to depreciation if I convert my rental property to a primary residence?

Depreciation stops the year you convert it. You can no longer claim the deduction because it is no longer held for the production of income. If you later convert it back to a rental, depreciation resumes based on the remaining useful life, but you cannot go back and claim depreciation for the years it was your home.