Depreciation is the single most powerful tax benefit available to real estate investors. It allows you to deduct a portion of your property's value each year as a "paper loss" — even while the property is actually appreciating. In many cases, a property generating positive cash flow can show a tax loss on paper, allowing investors to legally reduce or eliminate taxes on rental income.
How Rental Property Depreciation Is Calculated
The IRS allows residential rental properties to be depreciated over 27.5 years using the straight-line method. Here's the formula:
Annual Depreciation = Depreciable Basis ÷ 27.5
The depreciable basis is your purchase price plus closing costs, minus the value of the land (land cannot be depreciated). Example: You buy a rental home for $320,000. The assessor's records show land is 15% of value ($48,000). Depreciable basis = $272,000. Annual depreciation = $272,000 ÷ 27.5 = $9,890/year.
Tax Impact Example: If your rental generates $12,000 in net income but you have $9,890 of depreciation, your taxable income is only $2,110. At a 32% tax bracket, depreciation saves you $3,165 per year in federal taxes. Over 10 years, that's $31,650 in tax savings on a single property.
What Else Can Be Depreciated (Beyond the Building)
Depreciation isn't limited to the structure itself. Additional depreciable items include:
- Appliances and personal property (5 years): Refrigerators, stoves, carpeting, furniture in furnished rentals
- Land improvements (15 years): Driveways, fencing, landscaping, parking lots
- Capital improvements: Roof replacement, HVAC, new windows — depreciated over 27.5 years
- Closing costs: Loan origination fees, title insurance (amortized over loan term)
See Your Full After-Tax Returns
The Property Analyzer calculates pre-tax and post-depreciation returns so you see the true benefit of rental ownership.
Open Property Analyzer →Cost Segregation — Accelerating Your Depreciation
Cost segregation is an engineering study that reclassifies components of a building to shorter depreciation schedules. Interior fixtures, flooring, certain electrical systems, and other "personal property" components can be reclassified from 27.5-year to 5 or 7-year depreciation. Land improvements move to 15 years. The result: dramatically larger depreciation deductions in years 1-5 instead of spreading them over 27.5 years.
Combined with bonus depreciation (currently phasing down from 60% in 2024 toward 40% in 2025), cost segregation can generate six-figure paper losses in year one on large acquisitions. This strategy is most impactful for investors with high W-2 income who qualify as Real Estate Professionals under IRS rules.
Depreciation Recapture — What Happens When You Sell
The IRS eventually takes back depreciation through "recapture" at sale. Section 1250 recapture taxes the depreciation you claimed at a maximum 25% rate — separate from capital gains rates. If you claimed $100,000 in depreciation over 10 years and sell for a gain, $100,000 of that gain is taxed at 25% (up to your accumulated depreciation). The best defense: a 1031 exchange, which defers both capital gains and depreciation recapture indefinitely.
The Real Estate Professional Tax Status
Normally, rental losses are "passive" and can only offset other passive income. But if you qualify as a Real Estate Professional (750+ hours/year in real estate and more hours in RE than any other profession), rental losses become ordinary losses that can offset W-2 income. This is worth six figures per year in tax savings for the right investor. This advanced strategy is covered in detail in our Real Estate Tax Deductions guide.