Can You Write Off a Down Payment on Investment Property?

You cannot write off a down payment on an investment property in the year you make it. The IRS treats that money as a capital expenditure, meaning it becomes part of the property’s cost basis rather than a current-year deduction.¹ You do get the money back through tax deductions eventually, but the recovery happens gradually through depreciation over 27.5 years for a residential rental or 39 years for a commercial building.

Why the Down Payment Isn’t Deductible

Federal tax law separates money spent to acquire property from money spent to operate it. When you put $60,000 down on a $300,000 rental, that cash hasn’t disappeared. It has converted into equity in a physical asset. Because your net worth hasn’t dropped, the law doesn’t let you claim a loss.

If investors could deduct a full down payment immediately, every property purchase would generate a large paper loss that doesn’t reflect economic reality. Instead, acquisition costs stay on your books as part of the asset’s value. Trying to report a down payment as a direct expense on Schedule E is the kind of error that invites an IRS adjustment, plus penalties and interest on the underpayment.

What Your Down Payment Actually Becomes

Your down payment goes into the property’s cost basis, which is the starting number for every future tax calculation on that property. Basis equals your down payment plus the full mortgage balance you take on. Put $50,000 down and borrow $200,000, and your starting basis is $250,000.²

Certain closing costs also get added to basis rather than deducted as current expenses. Title insurance, legal fees for preparing the deed, recording fees, transfer taxes, and survey costs all count. If those items total $5,000, your adjusted basis rises to $255,000.²

Not everything on the closing statement qualifies. Casualty insurance premiums, rent you paid before closing to occupy the property, and loan origination charges are excluded from basis.² Hold on to your Closing Disclosure or HUD-1 Settlement Statement permanently. You’ll need it to prove which fees increased basis when you calculate gain on sale years later.

Capital improvements you make after purchase also get added to basis rather than deducted immediately. The IRS distinguishes improvements from repairs by asking whether the work created a betterment, restored the property to working condition after failure, or adapted it to a new use.³ Replacing a worn-out roof is a restoration. Adding a new deck is a betterment. Fixing a leaky faucet or repainting a room is a repair, and repairs are deductible in the year you pay them.

How Depreciation Gives You the Money Back

Depreciation is the mechanism that recovers the down payment for you, one year at a time. The deduction is available for property used in a trade or business or held to produce income.⁴ The recovery period depends on the property type:

Residential rental property: 27.5 years, straight-line method.
Commercial (nonresidential) real property: 39 years, straight-line method.

Both use the mid-month convention, which treats the property as placed in service at the midpoint of the closing month regardless of the actual day.⁵ A residential rental closed in January gets 11.5 months of depreciation in year one.

Only the building portion of your basis is depreciable. Land doesn’t wear out, so the IRS excludes it. If your $250,000 basis includes $50,000 for land, only the remaining $200,000 gets depreciated. Over 27.5 years, that produces roughly $7,273 per year in deductions. You report the calculation on Form 4562 and carry the result to Schedule E, where it reduces taxable rental income.⁶

This is where the down payment “write-off” actually lives. The $60,000 you put down isn’t deductible now, but its share of the building value flows into your depreciation deduction every year for nearly three decades. Commercial investors wait even longer at 39 years, which makes the annual deduction smaller per dollar of basis.⁷

Speeding Up the Recovery With Cost Segregation

Waiting decades for full recovery is slow. A cost segregation study can compress the timeline by identifying property components that qualify for shorter depreciation periods. An engineer examines the property and reclassifies items like appliances, cabinetry, carpeting, certain electrical systems, and site improvements such as parking areas, fencing, and landscaping into 5-year, 7-year, or 15-year recovery categories rather than lumping them into the building’s long life.

Shorter-lived components can qualify for bonus depreciation. Under the One Big Beautiful Bill Act, qualifying property placed in service after January 19, 2025, is eligible for 100% first-year bonus depreciation.⁸ Personal property components and land improvements identified through cost segregation can potentially be written off entirely in the first year of rental. The building structure itself still has to be depreciated over 27.5 or 39 years. Bonus depreciation doesn’t apply to residential rental buildings or commercial structures.

Cost segregation studies aren’t free, and they make the most financial sense on properties worth $500,000 or more. On the right property, reclassifying 20% to 30% of basis into shorter-lived categories can produce a six-figure first-year deduction well beyond what straight-line depreciation alone provides.

What You Can Deduct Right Away

The down payment isn’t deductible now, but many of the property’s ongoing costs are.

The interest portion of your monthly mortgage payment is deductible as a cost of borrowing money to produce rental income.⁹ The principal portion is not, because paying down a loan builds equity rather than creating an expense. In the early years of a mortgage, interest makes up most of the payment, so the deductible share is larger.

Real estate taxes on a rental are deductible on Schedule E in the year you pay them.⁶ So are insurance premiums, property management fees, advertising to attract tenants, travel to the property for maintenance, and routine repairs.¹⁰

Whether You Can Actually Use the Loss

Here is where many new investors get caught off guard. Even after depreciation, mortgage interest, property taxes, and operating expenses combine to produce a loss on paper, you may not be allowed to use that loss against your other income. Rental activities are generally classified as passive, and passive losses can only offset passive income.¹¹

There is a partial exception. If you actively participate in managing the rental by making decisions about tenants, repairs, and lease terms, you can deduct up to $25,000 in passive rental losses against your non-passive income. That allowance starts phasing out when modified adjusted gross income exceeds $100,000 and disappears entirely at $150,000. Married filing separately taxpayers who lived with a spouse at any point during the year drop to a $12,500 allowance with phase-out starting at $50,000.¹¹

Losses you cannot use now aren’t gone. They carry forward and can offset passive income in future years, or you can claim all accumulated suspended losses when you sell the property in a fully taxable transaction. Investors who qualify as real estate professionals under the strict 750-hour test can escape the passive limitation entirely, though a full-time W-2 employee who owns a few rentals on the side almost never meets it.¹²

What Happens to the Depreciation When You Sell

Every depreciation deduction you claim reduces the property’s adjusted basis, which increases your taxable gain when you sell. The IRS doesn’t let you take years of depreciation and then pay only capital gains rates on the profit. The portion of your gain attributable to prior depreciation is taxed at a maximum rate of 25% as unrecaptured Section 1250 gain, while the rest of the profit is taxed at ordinary long-term capital gains rates.¹³

Recapture applies whether the depreciation actually reduced your tax bill or was suspended by passive activity rules. The IRS calculates it based on depreciation that was “allowed or allowable,” which means the amount you should have claimed even if you forgot to. Skipping depreciation deductions doesn’t help you avoid recapture later.

A like-kind exchange under Section 1031 lets you defer both recapture and capital gains tax by rolling the proceeds into another investment property. No gain or loss is recognized as long as the replacement property is also real property held for business or investment use.¹⁴ The timelines are strict: 45 days from the sale to identify replacement properties in writing, and 180 days total to close on the purchase. Neither deadline can be extended except by a presidentially declared disaster.¹⁵

You also cannot touch the sale proceeds during the exchange period. A qualified intermediary has to hold the funds, and your real estate agent, attorney, or accountant, or anyone who has worked for you in those roles within the past two years, is disqualified from serving in that role.¹⁵ Investors who chain multiple exchanges over a career can defer recapture and capital gains indefinitely, and heirs who inherit the property receive a stepped-up basis that can eliminate the deferred gain entirely.

1
Office of the Law Revision Counsel. 26 USC 263 – Capital Expenditures
2
Internal Revenue Service. Publication 551, Basis of Assets
3
Internal Revenue Service. Tangible Property Final Regulations
4
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
5
Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
6
Internal Revenue Service. Publication 527, Residential Rental Property
7
Internal Revenue Service. Publication 946, How to Depreciate Property
8
Internal Revenue Service. One Big Beautiful Bill Provisions
9
Office of the Law Revision Counsel. 26 USC 163 – Interest
10
Internal Revenue Service. Tips on Rental Real Estate Income, Deductions and Recordkeeping
11
Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited
12
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
13
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
14
Office of the Law Revision Counsel. 26 U.S. Code 1031 – Exchange of Real Property Held for Productive Use or Investment
15
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031