How Does Depreciation Work for Rental Property?

Depreciation for a rental property is an annual deduction that lets you recover the cost of the building (not the land) over 27.5 years using the straight-line method, which comes out to about 3.636% of your depreciable basis each full year you own it. The deduction reduces the taxable rental income you report on Schedule E. It applies to residential rentals held to produce income, covers the structure and its improvements, and eventually gets partially clawed back through a recapture tax when you sell. Here is how each piece works, from the first year you place the property in service through the sale.

What You Can Actually Depreciate

Internal Revenue Code Section 167 allows depreciation on property you own and either use in a trade or business or hold to produce income.¹ A house or unit you rent to tenants meets that standard. A property you use only as your own home does not. If you lease a building from someone else and make improvements, only the improvements are yours to depreciate.

The property also has to wear out, decay, or become obsolete over time, and its useful life must extend well past a single year.² Land fails that test, so you never depreciate the land under the building.

One boundary worth naming: mixed personal-and-rental use. The IRS treats a dwelling as your personal residence once you use it yourself for more than the greater of 14 days or 10% of the days it is rented at fair market value.³ Past that line, rental expenses including depreciation can offset rental income but cannot create a loss you use against other income. And if you rent the place for fewer than 15 days all year, you skip reporting the income entirely, but you also cannot claim any depreciation on it.

Figuring Your Depreciable Basis

The dollar figure you actually depreciate each year is your depreciable basis, so this is the number worth getting right. Start with what you paid, which includes cash out of pocket, any mortgage you took on, and specific settlement costs. Publication 527 lists the closing items that get added to basis: abstract fees, legal fees, recording fees, title insurance, transfer taxes, survey costs, and charges for installing utilities.⁴ Mortgage points and lender-required appraisals do not go into basis.

From that total, subtract the value of the land. A common method uses the split shown on your local property tax assessment. If the assessor puts 25% of value on the land and 75% on the building, apply the same ratio to your purchase price. A professional appraisal is another option, especially where the tax roll looks off.

Inherited Property

If you inherited the rental rather than buying it, your basis is generally the fair market value on the date of death (or the alternate valuation date if the estate elected that option).⁵ That stepped-up figure resets the depreciation clock. You take out the land portion of the new value and begin a fresh 27.5-year schedule on the building.

Improvements Along the Way

A major improvement that adds value or extends the property’s life increases your basis, but it does not merge into the original schedule. Each improvement runs its own 27.5-year recovery (or a shorter one if it counts as personal property or a land improvement). A new roof in year five depreciates on its own track.

Small purchases have their own shortcut. The de minimis safe harbor election lets you expense items costing $2,500 or less per invoice in the year you buy them instead of depreciating them. A replacement disposal or a modest appliance fits. You make the election each year by attaching a statement to your return.

The 27.5-Year Schedule and Other Recovery Periods

The Modified Accelerated Cost Recovery System under IRC Section 168 sets the recovery period based on what you own.⁶ For a typical residential rental, that means:

Residential rental buildings: 27.5 years, straight-line, roughly 3.636% per full year.⁴
Nonresidential real property: 39 years, straight-line, roughly 2.564% per full year.²
Land improvements such as fences, sidewalks, driveways, and shrubbery: 15 years.²
Personal property inside the unit (appliances, carpeting, furniture): typically 5 or 7 years.

You do not get a full year in the first or last year. The mid-month convention treats real property as placed in service (or disposed of) at the midpoint of the month regardless of the actual date.² Close in July, and you get 5.5 months that year. Sell in March, and you get 2.5 months for the final year. Publication 946 has percentage tables that do the arithmetic based on the month you placed the property in service.

Front-Loading Deductions on Components

The 27.5-year schedule is the default, but two provisions let you accelerate deductions on shorter-lived items inside the property. Neither applies to the building shell itself.

Bonus depreciation under Section 168(k) is available for property with a recovery period of 20 years or less, which rules out both the residential building (27.5) and commercial building (39).⁶ It does apply to shorter-lived components: appliances, flooring, cabinetry, certain electrical systems, fencing, parking areas, and landscaping. The One Big Beautiful Bill restored 100% bonus depreciation for eligible property acquired after January 19, 2025, so qualifying components placed in service in the 2026 tax year can be deducted in full the first year.⁷

To unlock this on an existing purchase, investors often commission a cost segregation study. An engineer walks the property and reclassifies components out of the 27.5-year bucket and into 5-, 7-, or 15-year categories where bonus depreciation reaches them. On a $400,000 property, a study might move 15–25% of the building’s value into shorter-lived classes. The study itself has an upfront cost, so it usually pencils out for properties worth $500,000 or more.

Section 179 is the other path. It lets you deduct the full cost of tangible personal property placed inside a rental unit in the year of purchase, and since the Tax Cuts and Jobs Act, that includes appliances, carpeting, drapes, and blinds in residential rentals. The 2025 cap was $2,500,000 with a phase-out beginning at $4,000,000 of total property placed in service, adjusted yearly for inflation. Unlike bonus depreciation, Section 179 requires an affirmative election and cannot create or deepen a net loss from the activity.

Whether You Can Actually Use the Loss

Depreciation frequently puts a rental into a paper loss even when the cash flow is positive. Section 469 generally classifies rental activities as passive, and passive losses can only offset passive income.⁸ Owners frequently expect depreciation to reduce their W-2 income and find it does not.

There is a partial exception for active participants. If you approve tenants, sign off on repairs, and set the rental terms, you can deduct up to $25,000 in rental losses against nonpassive income like wages. That $25,000 allowance phases out once modified AGI passes $100,000, dropping by $1 for every $2 of income above the threshold, and it disappears entirely at $150,000.⁹

Losses you cannot use in a given year carry forward. They wait for future passive income to absorb them, and any remaining suspended losses release in full when you sell the property in a taxable transaction.

A separate exception exists for real estate professionals under Section 469(c)(7). You have to spend more than 750 hours during the year in real property trades or businesses in which you materially participate, and those hours must represent more than half of the personal services you perform in any trade or business that year.⁸ For a married couple, only one spouse needs to qualify, but that spouse has to meet both tests on their own. The status is realistic for full-time investors and hard to claim alongside another full-time job.

When Depreciation Starts and Stops

Depreciation begins when the property is placed in service for the production of income, meaning it is ready and available to rent even if no tenant has moved in.⁴ Finish the renovation and list the unit in October, and October is your start date.

It ends in one of three ways: you have fully recovered your basis, you sell the property, or you convert it entirely to personal use. Converting a rental into your own home does not erase the depreciation already claimed. It stays on the record and factors into your tax if you later sell.

Reporting It on Your Return

Annual rental depreciation goes on line 18 of Schedule E.¹⁰ You list rental income, subtract operating expenses and depreciation, and carry the net figure to your Form 1040. Form 4562 also has to be attached in three situations: the year you place property in service, any year you claim a Section 179 deduction, and any year that involves listed property like a vehicle.¹¹ For property placed in service in earlier years and still running on its standard schedule, Form 4562 is generally not required again.

What Happens When You Sell

Depreciation gives you a deduction now and a partial bill later. The portion of your gain attributable to depreciation you claimed, called unrecaptured Section 1250 gain, is taxed at a maximum federal rate of 25%, higher than the long-term capital gains rate on the rest of the profit.¹²

The rule that surprises owners: recapture is figured on depreciation “allowed or allowable,” whichever is greater.¹³ Owned a rental for ten years and never claimed depreciation? The IRS still reduces your basis by the amount you should have claimed and taxes you on that phantom depreciation at 25%. Skipping the deduction does not spare you from recapture. It just means you paid more tax every year and still owe the same amount at closing.

Recapture is reported on Part III of Form 4797. Any gain beyond the recapture piece moves to Form 8949 and Schedule D as capital gain.¹⁴

A like-kind exchange under Section 1031 defers both the capital gain and the recapture if you roll the proceeds into a qualifying replacement property. The gain is not forgiven, only postponed: your basis in the new property carries over from the old one, holding the deferred gain in reserve for a later sale.¹⁵ Chain enough exchanges together and the deferral can last a lifetime; heirs who inherit the property get a stepped-up basis that can wipe out the deferred gain entirely.

Fixing Missed Depreciation

If you never claimed depreciation on a rental you have owned for years, amended returns are not the fix. The IRS requires Form 3115, Application for Change in Accounting Method, to move from an impermissible method (not depreciating) to a permissible one. The relevant change number is DCN 7.¹⁶

The catch-up runs through a Section 481(a) adjustment. Because omitted depreciation produces a negative adjustment, you claim the entire accumulated amount as a deduction in a single tax year rather than spreading it across future years. You file the original Form 3115 with your timely-filed return for the year of change and mail a signed copy to the IRS National Office. It qualifies as an automatic change, so there is no user fee. Given how “allowed or allowable” works at sale, fixing missed depreciation before you sell is one of the cleaner planning moves available.

1
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
2
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
3
Internal Revenue Service. Topic No. 415, Renting Residential and Vacation Property
4
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
5
Internal Revenue Service. Publication 551, Basis of Assets
6
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
7
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
8
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
9
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
10
Internal Revenue Service. 2025 Instructions for Schedule E (Form 1040)
11
IRS. 2025 Instructions for Form 4562 – Depreciation and Amortization
12
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
13
Internal Revenue Service. Depreciation Recapture 3
14
Internal Revenue Service. Instructions for Form 4797
15
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
16
Internal Revenue Service. Instructions for Form 3115, Application for Change in Accounting Method