How to Depreciate Rental Property: Basis, Recovery, and Recapture

To depreciate a rental property, you divide the building’s depreciable basis (roughly the purchase price minus the land value) by 27.5 years and deduct that amount from your rental income every year the property is in service. The first and last years use a partial deduction based on the month you started renting. Depreciation is a paper expense: it lowers your taxable rental income without costing you anything out of pocket, and the IRS expects you to claim it every year you own the property.

What Qualifies for Depreciation

IRS Publication 527 sets four conditions the property has to meet. You have to own it. It has to produce income or serve a business purpose rather than function as your personal home. It has to have a determinable useful life. And it has to be expected to last more than a year.¹

Depreciation starts the moment the property is “placed in service,” which means ready and available to rent. You do not need a tenant signed up. If the unit is habitable and listed, the clock is running. Property bought to flip and resell quickly does not qualify, because it is not held for long-term rental use.

If You Converted Your Own Home Into a Rental

When you move out and start renting your former home, the starting number is not what you originally paid. You use the lesser of the property’s fair market value or your adjusted basis on the date you convert it.¹ Adjusted basis is your purchase price plus any capital improvements, minus any casualty loss deductions you took while living there. If home values fell after you bought, you are stuck with the lower fair market value.

If You Inherited the Property

Inherited property generally gets a stepped-up basis equal to fair market value on the date the prior owner died.² Whatever depreciation the previous owner claimed is wiped out. You begin a fresh 27.5-year schedule on the stepped-up value minus land.

Figuring the Depreciable Basis

The basis is the dollar figure you actually spread over 27.5 years. Getting it wrong means every future year’s deduction is wrong, so this step matters more than the arithmetic that comes after.

Start with cost basis: the full amount you paid, including cash, mortgage debt assumed, and closing costs like legal fees, recording fees, surveys, transfer taxes, title insurance, and any back taxes you agreed to cover.³ Loan origination fees and other costs of getting the mortgage are not part of property basis.

Then subtract land. Land does not wear out and cannot be depreciated.³ Most owners use the ratio on the local property tax assessment. If the county assigns 75% of value to the building and 25% to land, apply that same split to your purchase price. A professional appraisal is another option, and it makes sense when the assessment looks off or the parcel has unusual features.

Capital improvements made before renting, or during the rental period, increase the basis. An improvement adds value, extends useful life, or adapts the property to a new use: a new roof, an added bathroom, new plumbing, a central air system.³ Routine repairs that keep the property in its current condition, like patching a leak or repainting, are current-year expenses and do not affect basis. A useful shorthand: “fixing” is usually a repair, while “replacing” or “adding” is usually an improvement.

Running the Numbers

Residential rental property is depreciated under the Modified Accelerated Cost Recovery System, using the General Depreciation System with a 27.5-year recovery period and the straight-line method.¹ Straight-line means the same dollar amount every full year. A building with a $275,000 depreciable basis produces $10,000 of depreciation a year ($275,000 ÷ 27.5).

The Mid-Month Convention

The first year and the final year use a partial deduction. No matter what day you actually place the property in service, the IRS treats it as the 15th of that month.¹ Place a unit in service any day in March and you get 9.5 months of depreciation that first year. Place it in October and you get 2.5 months.

The IRS publishes a first-year percentage for each month. A property placed in service in January gets 3.485% of basis the first year. May is 2.273%. September is 1.061%. December is 0.152%. Multiply your depreciable basis by the applicable percentage for your first-year deduction. Every full year after that, the deduction is 3.636% of basis (1/27.5). The same mid-month math applies in the year you sell or take the property out of service.

Faster Deductions on Building Components

The 27.5-year timeline applies to the structure. Not everything inside or around the property is part of the structure, and the IRS assigns shorter recovery periods to specific components:

5-year property: appliances like stoves and refrigerators, carpeting, and furniture used in the rental.
7-year property: office furniture and equipment such as desks and file cabinets.
15-year property: land improvements such as roads, fences, and shrubbery.¹

Shorter-lived items produce larger annual deductions because the cost is spread over fewer years. When you buy a furnished rental or install new appliances, put those items on their own schedule rather than folding them into the building.

A cost segregation study is an engineering-based analysis that reclassifies components most owners would not think to separate, such as certain electrical systems, decorative finishes, and site improvements, into 5-year or 15-year categories. Industry estimates put 20% to 40% of a rental’s depreciable value as eligible to shift into these shorter buckets. Studies typically cost between $5,000 and $15,000 for residential properties, so they pay off on higher-value buildings where the tax savings comfortably clear the fee.

Cost segregation pairs with bonus depreciation. The One Big Beautiful Bill Act restored 100% bonus depreciation for qualifying property placed in service after January 19, 2025, letting you deduct the full cost of eligible assets in the first year.⁴ The building itself does not qualify because its recovery period is over 20 years. The shorter-lived components a cost segregation study identifies do qualify, which is how some investors generate large paper losses in the year they buy.

Whether You Can Actually Use the Loss This Year

Depreciation often turns a profitable rental into a paper loss on your return. Before assuming that loss cuts your tax bill, check the passive activity rules. The IRS classifies rental real estate as a passive activity for most taxpayers, and passive losses generally cannot offset wages, salaries, or other non-passive income.⁵

There is a $25,000 special allowance for owners who actively participate, meaning you make management decisions like approving tenants, setting rent, and authorizing repairs. The allowance phases out as modified adjusted gross income rises above $100,000, dropping by $1 for every $2 over the threshold, and disappears at $150,000.⁵ Losses you cannot use carry forward; they can offset passive income later or are fully deductible when you sell.

If you qualify as a real estate professional, the passive limitation goes away entirely. The bar is high: more than 750 hours a year in real property trades or businesses in which you materially participate, and more than half of all your personal services across every trade or business.⁵ Employee hours do not count unless you own at least 5% of the employer. For a married couple filing jointly, only one spouse has to independently hit the 750 hours.

Where Depreciation Goes on Your Return

Rental income, expenses, and depreciation are reported on Schedule E (Form 1040). Depreciation appears on Line 18 as a non-cash expense that reduces taxable rental income.⁶

You also file Form 4562 (Depreciation and Amortization) any year you place new depreciable property in service.⁷ The form records the placed-in-service date, depreciable basis, recovery period, and convention. In later years, you only need Form 4562 if you are adding new assets or claiming depreciation on listed property. Otherwise the annual number flows straight onto Schedule E from your records.

If You Skipped Depreciation in Prior Years

Owners who did not claim depreciation, either because they did not know they could or because they thought skipping it would help at sale, run into a hard rule. The IRS reduces your basis by depreciation “allowed or allowable,” whichever is greater. You owe recapture tax on depreciation you should have taken even if you never actually took it.⁸

If you missed one year, you can fix it with an amended return for that year. If you missed two or more, the IRS requires Form 3115 (Application for Change in Accounting Method). The unclaimed depreciation is treated as a favorable adjustment and deducted in full on your return for the year of change.⁹ Form 3115 is complicated enough that most owners bring in a tax professional, but pulling years of missed deductions into a single return is usually worth the effort.

What Depreciation Costs You at Sale

Every dollar of depreciation you claim, or should have claimed, lowers your adjusted basis. When you sell above that reduced basis, the portion of your gain attributable to depreciation is taxed as unrecaptured Section 1250 gain at a maximum federal rate of 25%.¹⁰ Any gain above total depreciation taken is taxed at the standard long-term capital gains rates of 0%, 15%, or 20%, depending on income.

A simple example: you buy a rental for $300,000, allocate $250,000 to the building, and claim $50,000 of depreciation over several years. Adjusted basis is now $250,000. Sell for $350,000 and your gain is $100,000. The first $50,000 is taxed at up to 25%. The remaining $50,000 is taxed at your long-term capital gains rate.

Because recapture uses “allowed or allowable,” skipping depreciation during your holding period does not shrink the recapture bill. It just means you paid more tax every year along the way and still owe the same amount at the end.⁸

1
Internal Revenue Service. Publication 527 – Residential Rental Property
2
Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent
3
Internal Revenue Service. Publication 551 – Basis of Assets
4
Internal Revenue Service. One, Big, Beautiful Bill Provisions
5
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
6
Internal Revenue Service. 2025 Instructions for Schedule E (Form 1040)
7
Internal Revenue Service. Instructions for Form 4562
8
Internal Revenue Service. Depreciation Recapture 3
9
Internal Revenue Service. Instructions for Form 3115
10
Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed