Residential Rental Property Depreciation: Basis, ADS, and Recapture

Residential rental property depreciation lets you deduct the cost of a rental building, minus the land, evenly over 27.5 years under the Modified Accelerated Cost Recovery System.¹ That annual write-off reduces your taxable rental income, often turning a cash-positive property into a paper loss for tax purposes. The rules live in IRC Section 168 and a handful of IRS publications, and they cover four things you need to get right: what qualifies, how to figure the basis, how to calculate the deduction, and what happens when you sell.

What Counts as Residential Rental Property

A building qualifies when 80 percent or more of its gross rental income for the year comes from dwelling units — houses or apartments used for living accommodations.² Hotels, motels, and similar establishments where more than half the units serve transient guests are excluded. If you live in part of the building yourself, the rental value of your own unit counts toward the 80 percent.

Getting the classification wrong is expensive. Fail the test and the building becomes nonresidential real property with a 39-year recovery period, cutting your yearly deduction. The ratio needs a fresh look every year, because a change in tenant mix or a unit conversion can push you over the line.

Short-term rentals sit in a gray zone. A property that is regularly available to paying customers and never used as the owner’s home can be treated as a hotel-like establishment and lose the 27.5-year classification.³ Vacation rentals aren’t automatically disqualified, but the transient-use analysis matters. And a property held purely for personal use, like a family beach house you never rent, gets no depreciation at all.

Figuring Your Depreciable Basis

Your depreciable basis is the dollar amount you actually spread over 27.5 years. Start with the purchase price plus qualifying closing costs — title insurance, recording fees, abstract fees.⁴ Prepaid insurance and prorated rent for occupying the property before closing are not part of basis.

Now subtract the land. Land never depreciates because it doesn’t wear out.⁴ The easiest allocation method uses your local property tax assessment, which typically breaks assessed value into land and improvements; apply that ratio to your total cost. A professional appraisal produces a more defensible split for expensive properties or unusual lots.

Improvements Add to Basis, Repairs Don’t

Money spent after purchase splits into two categories. A capital improvement — anything that betters the property, restores it, or adapts it to a new use — gets added to basis and depreciated over its own recovery period as a separate asset.³ A new roof or an added bathroom is an improvement. Routine repairs, like patching a leak or repainting, are deducted in full the year you pay.

The de minimis safe harbor election lets you skip the improvement analysis for smaller purchases and deduct amounts up to $2,500 per item, or $5,000 if you have audited financial statements.⁵

Conversions and Inheritances Change the Starting Number

Converting a former home into a rental? Your depreciable basis is the lesser of the property’s fair market value on the conversion date or your adjusted basis at that time.⁴ Buy at $350,000, convert when the property is worth $280,000, and you depreciate the lower figure (minus land). Get an appraisal on the conversion date; it documents both the FMV and the land split.

Inherited property gets stepped-up basis. Your starting point is generally the fair market value on the date the previous owner died, not what they paid.⁶ The 27.5-year clock resets, even if the decedent had already fully depreciated the building.

How to Calculate the Annual Deduction

Divide the building’s depreciable basis by 27.5. That is your full-year deduction under the straight-line method used by the General Depreciation System.⁷ A $275,000 basis gives you $10,000 a year. A $412,500 basis gives you $15,000.

The first and last years use the mid-month convention. Property placed in service (or disposed of) during any month is treated as if it started or stopped at the midpoint of that month.³ Place a rental in service in March and you get 9.5 months of depreciation that year (half of March plus April through December), so multiply the annual figure by 9.5/12. Sell in October and you get the same 9.5-month share on the way out. The convention keeps total depreciation over the property’s life from exceeding the original basis.

Faster Write-Offs for Components

The building itself follows the 27.5-year schedule, but items in and around it don’t have to. MACRS assigns shorter lives to certain components:

5-year property: appliances like stoves and refrigerators, carpeting, and furniture used in the rental.³
15-year property: land improvements such as fences, driveways, sidewalks, and landscaping.¹

These shorter-lived assets can also qualify for 100 percent bonus depreciation, which deducts the whole cost in year one. The One, Big, Beautiful Bill Act permanently restored 100 percent bonus depreciation for qualified property acquired after January 19, 2025.⁸ The 27.5-year building itself does not qualify; only the shorter-lived components do.

A cost segregation study is the formal way to identify what qualifies. An engineer or tax specialist reviews the property and reclassifies items like specialized electrical wiring, decorative fixtures, and site work into 5-, 7-, or 15-year buckets. Fees run from a few hundred dollars for simple properties to $25,000 or more for large or complex buildings. Tax savings usually outweigh the cost for properties valued at $500,000 and above, but the payoff depends on how much gets reclassified and your marginal rate.

One caveat: Section 179 expensing generally does not apply to residential rental property. That benefit is largely limited to nonresidential real property improvements.

When ADS Applies Instead

Some situations force you onto the Alternative Depreciation System. For residential rental property placed in service after 2017, the ADS recovery period is 30 years.³ Property placed in service before 2018 uses 40 years, with limited exceptions.

ADS is mandatory for property used predominantly outside the United States and property financed with tax-exempt bonds. It also applies when a real property trade or business elects out of the Section 163(j) business interest deduction limit, trading slower depreciation for unlimited interest deductions. Once you’re on ADS for a property, you generally can’t switch back.

Can You Actually Use the Deduction?

Depreciation often produces a paper loss on the rental, and this is where landlords hit the passive activity rules. Federal law treats nearly all rental activity as passive, no matter how much time you put in.⁹ Passive losses can generally only offset passive income.

The main exception: if you actively participate — approving tenants, setting terms, authorizing repairs — you can deduct up to $25,000 of rental losses against nonpassive income each year.¹⁰ Active participation is a low bar, but you need at least a 10 percent ownership interest.¹¹

The $25,000 allowance phases out as income rises. Once your modified adjusted gross income exceeds $100,000, the allowance drops by 50 cents for every dollar above that threshold. At $150,000 modified AGI, it’s gone.⁹ Losses you can’t use aren’t lost; they carry forward and offset future passive income or reduce your gain at sale.

Taxpayers who qualify as real estate professionals can treat rental losses as nonpassive, avoiding the ceiling and the phaseout entirely. The threshold is more than 750 hours a year in real property trades or businesses, representing more than half of your total personal services.¹¹

Reporting Depreciation on Your Return

Depreciation goes on Form 4562, which asks for the placed-in-service date, cost basis, recovery period, and method.¹² Separate sections handle current-year and prior-year property. The total flows to Schedule E, where it reduces rental income or increases your rental loss. If passive loss limits apply, Form 8582 calculates how much of the loss you can actually deduct.¹⁰

What If You Forgot to Depreciate?

Skipping depreciation is more common than you’d think, and it hurts twice. Under the “allowed or allowable” rule, you must reduce your basis by the full depreciation you were entitled to take, whether you actually claimed it or not.¹ You get no benefit during ownership and a bigger taxable gain at sale.

The fix is Form 3115, Application for Change in Accounting Method, not amended returns. Depreciation corrections fall under automatic change procedures (designated change number 7), so no advance IRS approval and no user fee.¹³ You calculate a Section 481(a) adjustment for all the depreciation you should have claimed and take that cumulative catch-up deduction in the year of the change. Attach the original to your timely filed return and send a copy to the IRS National Office.

Recapture When You Sell

Depreciation doesn’t vanish at sale. The IRS claws some of it back through unrecaptured Section 1250 gain, taxing the portion of your profit attributable to prior depreciation (or allowable depreciation) at a federal rate of up to 25 percent, rather than the lower long-term capital gains rates on the rest.¹⁴ The sale gets reported on Form 4797, which separates recapture from ordinary capital gain.¹⁵

Numbers make it concrete. Buy a rental for $300,000, allocate $240,000 to the building, and claim $87,273 in depreciation over 10 years. Adjusted basis is $212,727. Sell for $350,000 and your total gain is $137,273. The $87,273 tied to depreciation faces the 25 percent recapture rate; the remaining $50,000 is taxed at your long-term capital gains rate. And because allowed-or-allowable applies, a landlord who never claimed depreciation still owes recapture on the amount they could have claimed. That’s exactly why leaving the deduction on the table is the most expensive mistake in this whole system.

1
Internal Revenue Service. Publication 946 – How To Depreciate Property
2
Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
3
Internal Revenue Service. Publication 527 – Residential Rental Property
4
Internal Revenue Service. Publication 551 – Basis of Assets
5
Internal Revenue Service. Tangible Property Final Regulations
6
Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent
7
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
8
Internal Revenue Service. One, Big, Beautiful Bill Provisions
9
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
10
Internal Revenue Service. Instructions for Form 8582
11
Internal Revenue Service. Publication 925 – Passive Activity and At-Risk Rules
12
Internal Revenue Service. Instructions for Form 4562
13
Internal Revenue Service. Instructions for Form 3115
14
Internal Revenue Service. Topic No. 409 – Capital Gains and Losses
15
Internal Revenue Service. Instructions for Form 4797