How to Calculate Depreciation on Commercial Real Estate

To calculate depreciation on commercial real estate, subtract the land value from your total cost basis, then divide the remaining building value by 39 years using the straight-line method. The IRS applies a mid-month convention that reduces your deduction in the year you place the building in service and the year you dispose of it. On a $1,000,000 depreciable basis, that works out to $25,641 per year for every full year of ownership.

The formula is simple. The work is in getting the inputs right and knowing which parts of the property qualify for faster write-offs.

The Basic Formula

Commercial buildings fall under the Modified Accelerated Cost Recovery System, and the IRS assigns nonresidential real property a 39-year recovery period.1Internal Revenue Service. Publication 946, How To Depreciate Property – Section: Recovery Periods Under GDS This category covers office buildings, warehouses, retail stores, industrial facilities, and any other structure where tenants don’t live. Residential rental uses a shorter 27.5-year schedule, so confirm your property type before you start.

Divide your depreciable basis by 39 to get the annual deduction:

$1,000,000 ÷ 39 = $25,641 per year

That amount stays the same for every full year the building is in service. Straight-line is the only method allowed for commercial real property. You cannot use accelerated methods like double-declining balance on the building itself.2Internal Revenue Service. Instructions for Form 4562 – Section: Column (f) Method

Figuring Your Depreciable Basis

Your depreciable basis is the total dollar amount you’re allowed to write off over time. It starts with the purchase price under the cost-basis rules of the federal tax code.3Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property-Cost Certain acquisition costs get added to that figure rather than deducted as current expenses:

  • Legal fees for title work and contract review
  • Recording fees
  • Transfer taxes
  • Title insurance premiums
  • Survey costs

Together these items can add several thousand dollars to your starting figure. Then subtract the value of the land. Land never depreciates under the tax code because it doesn’t wear out or become obsolete.4Internal Revenue Service. Publication 946, How To Depreciate Property – Section: What Property Cannot Be Depreciated? Only the physical structure and permanently attached improvements are eligible. If you paid $1,200,000 total and the land is worth $200,000, your depreciable basis is $1,000,000.

Splitting Land From Building

There’s no single IRS-approved method for allocating the purchase price between land and building. The most common approach is to use the local property tax assessment, which usually breaks out land and improvement values separately. If the assessment shows 18% land and 82% building, applying those percentages to your purchase price gives you a defensible starting point.

A stronger method is hiring a certified appraiser to value the land and building independently as of the purchase date. A professional appraisal holds up better than a tax-assessment ratio if the IRS ever questions your allocation, especially on high-value properties where the stakes of getting the split wrong are substantial. Expect to pay roughly $2,000 to $4,000 for a commercial property appraisal, depending on the building’s complexity and location.

The Mid-Month Convention

You don’t get a full year of depreciation in the year you buy or sell. Federal tax law requires the mid-month convention for all real property, meaning the IRS treats you as though you placed the building in service at the midpoint of whichever month the purchase closed.5Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System – Section: (d) Applicable Convention It doesn’t matter whether you closed on the 1st or the 31st.

First-Year Calculation

Count the months from the midpoint of the acquisition month through December, divide by 12, and multiply by the full-year amount. A June closing gives you credit for 6.5 months (half of June plus July through December):

$25,641 × (6.5 ÷ 12) = $13,889

A January closing nets you 11.5 months of depreciation that first year. A December closing gives you just half a month. This makes the closing date worth thinking about at year-end.

Final-Year Calculation

The same logic applies in reverse when you sell or take the building out of service. The IRS treats the disposal month as a half-month. Selling in October gives you 9.5 months of depreciation for that final tax year:

$25,641 × (9.5 ÷ 12) = $20,299

These fractional calculations ensure the total depreciation claimed across all years of ownership never exceeds the original depreciable basis.6Internal Revenue Service. Publication 946, How To Depreciate Property – Section: Mid-Month Convention

Getting More Than the 39-Year Number

The 39-year straight-line schedule applies to the building structure. But not everything inside or around the building is structural, and a cost segregation study reclassifies components into shorter recovery periods that dramatically accelerate deductions in the early years.

The IRS classifies certain assets as 5-year, 7-year, or 15-year property even when they’re part of a commercial building purchase:

A cost segregation study typically runs $5,000 to $10,000 when done by a traditional engineering firm. The study usually pays for itself many times over on buildings worth $750,000 or more, because the accelerated deductions create immediate cash flow through lower tax bills.

Qualified Improvement Property

Interior improvements to a nonresidential building placed in service after the building itself was originally put into use qualify as Qualified Improvement Property. The CARES Act assigned QIP a 15-year recovery period.9United States Code. 26 USC 168(e)(6) – Qualified Improvement Property Definition QIP includes new lighting, flooring, drywall, and interior finishes, but not building enlargements, elevators, escalators, or changes to the internal structural framework.10Internal Revenue Service. Publication 946, How To Depreciate Property – Section: Qualified Improvement Property

Bonus Depreciation

The One Big Beautiful Bill Act permanently restored 100% first-year bonus depreciation for qualifying property acquired and placed in service after January 19, 2025.11Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill The building itself does not qualify. The law limits the deduction to property with a recovery period of 20 years or less.12Office of the Law Revision Counsel. 26 USC 168(k) – Special Allowance for Certain Property That means bonus depreciation is available for cost segregation components reclassified into 5-, 7-, or 15-year property; Qualified Improvement Property at 15 years; and land improvements like fences, sidewalks, and parking lots at 15 years. Without a cost segregation study, most of these components stay buried in the 39-year building classification and never reach the bonus threshold.

Section 179

Section 179 offers another path to first-year expensing for certain commercial real estate costs. The building structure is not eligible, but qualifying interior improvements, roofs, HVAC systems, fire protection and alarm systems, and security systems can be expensed immediately. The maximum Section 179 deduction for 2026 is approximately $2.5 million, with a phaseout beginning when total qualifying property placed in service exceeds roughly $4 million. Unlike bonus depreciation, Section 179 cannot create or increase a net operating loss. Your deduction is limited to taxable income from active business sources.

Repairs vs. Improvements

After you buy the building, every dollar you spend on it raises the same question: does this get added to the depreciable basis or written off immediately as a repair? The answer hinges on whether the work counts as an improvement under the IRS tangible property regulations.13Internal Revenue Service. Tangible Property Final Regulations A cost must be capitalized if it betters the property (fixes a pre-existing defect, adds capacity or square footage, or materially increases efficiency), restores it (replaces a major component or rebuilds it to like-new condition), or adapts it to a new use inconsistent with the original.

Routine maintenance that keeps the building in ordinary operating condition is deductible as a current repair expense. Patching a section of roof, repainting walls, and fixing a broken HVAC compressor are repairs. Replacing the entire roof or gutting and rebuilding the HVAC system is a capital improvement that gets added to your basis and depreciated over a new recovery period.

What Happens When You Sell

Every dollar of depreciation you claimed comes back into play when you sell. The IRS taxes the gain attributable to prior depreciation deductions at a maximum rate of 25%, known as the unrecaptured Section 1250 gain rate.14Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed – Section: (h) Maximum Capital Gains Rate This rate applies regardless of your ordinary income bracket and is separate from the long-term capital gains rate on any additional appreciation above your original purchase price.

Say you bought a commercial building for $1,200,000 with a $1,000,000 depreciable basis. After 15 years, you’ve claimed roughly $384,615 in depreciation, making your adjusted basis $815,385. If you sell for $1,400,000, two different rates apply. The $384,615 of claimed depreciation is unrecaptured Section 1250 gain, taxed at up to 25%. The $200,000 of appreciation above your original price is taxed at your applicable long-term capital gains rate of 0%, 15%, or 20%.

You report the sale and recapture on Form 4797, Sales of Business Property.15Internal Revenue Service. Form 4797 – Sales of Business Property Owners who used cost segregation or bonus depreciation to take larger early deductions face a proportionally larger recapture bill on sale, so the tax deferral is real but not permanent.

Where to Report the Deduction

Annual depreciation for commercial real estate goes on Form 4562, Depreciation and Amortization. Nonresidential real property is reported on line 19j. Enter the month and year placed in service, the depreciable basis, “MM” for the mid-month convention, “S/L” for straight-line, and the 39-year recovery period.16Internal Revenue Service. Instructions for Form 4562 – Section: Lines 19a Through 19j Each property gets its own line.

If you used cost segregation to reclassify components into shorter recovery periods, those assets go on separate lines in Part III of the same form. Components eligible for bonus depreciation are reported in Part II. Keep clean records from the start: your allocation between land and building, any cost segregation study, and your placed-in-service date. That paperwork makes annual filing straightforward and keeps you from scrambling if the IRS questions a return years later.