Real Estate Depreciation: Recovery Periods, Deductions, and Recapture

Real estate depreciation is a federal income tax deduction that lets the owner of a rental or business building recover its cost gradually over the years the structure is producing income, rather than all at once in the year of purchase. For residential rental property the write-off is spread across 27.5 years; for commercial buildings it runs 39 years. Each year’s deduction reduces your taxable rental income directly. And the IRS treats it as effectively mandatory: if you skip it, the agency still reduces your property’s tax basis as though you had claimed it, so you pay the tax on sale either way.

What Property Qualifies

Federal tax law allows depreciation on property that wears out while being used in a business or held to produce income.¹ To take the deduction on a building, four things must all be true:

You hold title, even if the property is mortgaged.
You use it to produce income or run a business. A rental house, a leased office, or a warehouse used in your own company qualifies. A home you live in and never rent does not.
The asset has a limited useful life. Buildings wear out; raw land does not.²
It lasts more than one year. Anything that wears out inside a year is expensed instead.

Land is the item people most often try to depreciate by mistake. Because it doesn’t wear out or become obsolete, the IRS never allows a deduction for it. When you buy an improved property, you split the price between the land and the building and put only the building portion on the schedule.

If you convert a former home into a rental, depreciation starts at the conversion date. The depreciable basis is the lesser of your adjusted cost basis or the property’s fair market value on the date of conversion.² If the home has lost value since you bought it, you’re stuck with the lower figure.

Figuring the Depreciable Basis

Your basis starts with what you paid, plus certain settlement costs: legal fees, title insurance, recording fees, and survey costs. Seller obligations you assumed at closing, such as back taxes, also increase basis.³

Once you have total acquisition cost, carve out the land value. The common method is to use the ratio from your local property tax assessment. If the county assessor puts 25% of the assessed value on land and 75% on improvements, apply that 75% to your total cost to find the depreciable basis. A professional appraisal is an alternative and is worth the money when the tax assessment looks unreliable.

Capital improvements after purchase add to basis. A new roof, an added bedroom, a converted garage. The line between improvement and repair matters here: an improvement adds value, extends useful life, or adapts the property to a new use, while a repair keeps things as they are. Replacing a broken window is a repair, deducted as a current expense. Replacing every window with energy-efficient units is an improvement, depreciated over time.

Recovery Period: 27.5 or 39 Years

The Modified Accelerated Cost Recovery System (MACRS) assigns each type of property a fixed recovery period.⁴ Real property falls into two buckets:

Residential rental property, 27.5 years. A building qualifies as residential rental when 80% or more of its gross rental income comes from dwelling units. Apartments, duplexes, single-family rentals, and townhomes all fit. Hotels and motels where more than half the units serve transient guests do not.
Nonresidential real property, 39 years. Office buildings, retail space, warehouses, and any rental building that doesn’t clear the 80% residential threshold.

Not every asset inside the building runs on the same schedule. Appliances, carpeting, and furniture use 5- or 7-year recovery. Land improvements such as fences, sidewalks, and landscaping structures use 15 years.² Sorting those components out is what makes a cost segregation study valuable, discussed below.

Interior improvements to a nonresidential building after it’s already in service get their own category, qualified improvement property (QIP), with a 15-year recovery period.⁴ Improvements that enlarge the building, add an elevator or escalator, or alter its structural framework are excluded.

A different set of rules, the Alternative Depreciation System (ADS), stretches the periods to 30 years residential and 40 years commercial. ADS applies in specific cases, including property used predominantly outside the United States and certain tax-exempt use property. Most domestic landlords will not use it.

Calculating the Annual Deduction

Real estate always uses straight-line depreciation, meaning the same amount comes off every full year.⁴ Divide the depreciable basis by the recovery period. A residential rental with a $275,000 building basis produces a $10,000 annual deduction ($275,000 ÷ 27.5). A commercial building with the same basis yields about $7,051 per year ($275,000 ÷ 39).

The first and last years are prorated using the mid-month convention. The IRS treats you as placing the property in service, or disposing of it, at the midpoint of the month regardless of the actual date.⁴ Close on a residential rental in March and you get 9.5 months that year. Take the full-year figure, divide by 12, multiply by 9.5. The same partial-year math applies in the year you sell.

Depreciation is reported on Form 4562, Depreciation and Amortization. Part III covers MACRS real property; you enter the classification, date placed in service, depreciable basis, recovery period, convention, and calculated deduction.⁵ For rentals, the resulting deduction flows through to Schedule E.

When Depreciation Begins and Ends

Depreciation starts when the property is placed in service, meaning it’s ready and available for its intended use.⁶ For a rental, that’s the moment the unit is habitable and offered for rent. A tenant does not need to have moved in yet. A newly built rental qualifies the day it’s ready for occupancy, even if it sits empty for months.

You keep claiming depreciation each year until one of three things happens: you’ve fully recovered the depreciable basis, you sell or exchange the property, or you convert it to personal use. Move back into a former rental and depreciation stops on the conversion date. If a casualty destroys the building, it ends at the date of loss.

Cost Segregation and Bonus Depreciation

Straight-line over 27.5 or 39 years is the default for the building shell, but individual components can be pulled onto much faster schedules through a cost segregation study. The study breaks the building into its parts and reclassifies items that qualify for shorter recovery: interior fixtures, certain plumbing and electrical systems, decorative finishes, parking lots, landscaping structures. Those pieces move from the long building schedule into 5-year, 7-year, or 15-year categories.

Combined with bonus depreciation, the numbers get much larger. Under the One Big Beautiful Bill Act of 2025, qualified property acquired after January 19, 2025 is eligible for a permanent 100% first-year depreciation deduction.⁷ Qualified property generally means assets with a recovery period of 20 years or less. The 27.5- or 39-year building shell doesn’t qualify. But the 5-year carpeting, 7-year cabinetry, and 15-year land improvements identified in a cost segregation study do.

On a $1 million commercial building, a study might reclassify $200,000 to $350,000 of components into the shorter-lived categories eligible for 100% bonus depreciation. Instead of roughly $25,600 the first year under straight-line alone, the first-year deduction can reach several hundred thousand dollars. Professional fees for the study typically run $5,000 to $15,000, usually a fraction of the first-year tax savings.

Qualified improvement property gets the same treatment. QIP placed in service after January 19, 2025 qualifies for 100% bonus depreciation, so interior renovations to a commercial building can be written off entirely in the year the work is finished rather than spread over 15 years.

Using Rental Losses Against Other Income

Depreciation frequently pushes a cash-positive rental into a paper loss on Schedule E. Whether you can use that loss against your salary or other non-rental income is a separate question. The IRS generally treats rental activities as passive, and passive losses only offset passive income.⁸

Smaller landlords get an exception. If you actively participate in managing the property (approving tenants, authorizing repairs, setting rent), you can deduct up to $25,000 of rental losses against non-passive income each year. The full $25,000 is available when your modified adjusted gross income is $100,000 or less. Above that, the allowance shrinks by 50 cents per dollar of income over $100,000, and it disappears completely at $150,000.⁸

Losses you can’t use carry forward. They can offset passive income in later years or are fully released against any income when you sell the property in a taxable transaction.

The passive limits fall away entirely for someone who qualifies as a real estate professional: more than 750 hours during the year in real property businesses where you materially participate, and more than half of your total working hours in those activities.⁹ Employee hours in real estate count only if you own more than 5% of the employer. The threshold is designed for people whose primary career is real estate, not for a full-time professional with a couple of rentals on the side.

Depreciation Recapture When You Sell

The catch investors often ignore until closing: the IRS wants some of those deductions back on sale. Every dollar of depreciation claimed reduced your adjusted basis, which increases your taxable gain. The portion of the gain attributable to depreciation is taxed at your ordinary income rate or a 25% maximum, whichever is less.¹⁰ Any gain above the recaptured amount is taxed at the long-term capital gains rate.

An example. You buy a rental for $300,000, with $240,000 allocated to the building. After ten years of straight-line depreciation at roughly $8,727 per year, you’ve claimed about $87,270. Your adjusted basis is $212,730. Sell for $350,000 and your total gain is $137,270. The first $87,270 is depreciation recapture taxed at up to 25%; the remaining $50,000 is taxed at capital gains rates.

Here’s the trap. The IRS reduces your basis for depreciation that was “allowed or allowable,” meaning the greater of what you actually claimed or what you should have claimed.¹¹ Own a rental for ten years and never take depreciation, and the IRS still cuts your basis as if you had.¹² You’d owe recapture on deductions you never used. Skipping depreciation on a rental is giving the IRS free money.

High-income sellers face an extra 3.8% net investment income tax on gain from investment real estate when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). These thresholds are not adjusted for inflation.¹³

Two well-known ways to postpone or eliminate the recapture bill. A Section 1031 like-kind exchange defers both capital gains and recapture by rolling your basis into a replacement investment property; keep exchanging into qualifying properties and the tax is postponed indefinitely. Hold the property until death and your heirs get a stepped-up basis that wipes out the accumulated recapture entirely, which is one of the larger wealth-transfer advantages in the tax code.

1
Office of the Law Revision Counsel. 26 U.S. Code 167 – Depreciation
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
Office of the Law Revision Counsel. 26 U.S. Code 1011 – Adjusted Basis for Determining Gain or Loss
4
Office of the Law Revision Counsel. 26 U.S.C. 168 – Accelerated Cost Recovery System
5
Internal Revenue Service. Instructions for Form 4562
6
Internal Revenue Service. Publication 946 – How To Depreciate Property
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 U.S.C. 469 – Passive Activity Losses and Credits Limited
9
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
10
Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed
11
Office of the Law Revision Counsel. 26 U.S.C. 1016 – Adjustments to Basis
12
Internal Revenue Service. Depreciation and Recapture 3
13
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax