Section 168 of the Internal Revenue Code sets the rules for depreciating real estate used in a trade, business, or rental activity. Under Section 168, real estate depreciation works on fixed recovery periods (27.5 years for residential rentals, 39 years for nonresidential buildings, and 15 years for land improvements), all on a straight-line basis, with shorter-lived components inside the building eligible for accelerated write-offs and, for property acquired after January 19, 2025, a permanent 100 percent bonus depreciation deduction restored by the One, Big, Beautiful Bill.
Recovery Periods by Property Type
Classification is the first thing that determines how quickly you recover a building’s cost. Section 168(c) assigns three recovery periods that matter to most real estate owners.1Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
- Residential rental property, 27.5 years. A building qualifies as residential rental if 80 percent or more of its gross rental income comes from dwelling units. Apartments, duplexes, single-family rentals, and rented condos fall here.2Cornell Law Institute. 26 USC 168(e)(2) – Residential Rental or Nonresidential Real Property
- Nonresidential real property, 39 years. Offices, warehouses, retail spaces, and anything else that doesn’t clear the 80 percent dwelling-unit test.
- Land improvements, 15 years. Sidewalks, driveways, fences, parking lots, and landscaping depreciate on their own schedule, separate from the building.
All three use the straight-line method under the General Depreciation System: the same dollar amount each year, adjusted only for the partial first and last years. A $2.75 million apartment building generates about $100,000 in annual depreciation before any bonus provisions layer on top.
Short-term rentals sit inside the same recovery periods. A property rented on platforms like Airbnb with an average guest stay of seven days or less is treated as an active business rather than a passive rental under Section 469, which changes how losses flow through your return but does not change the building’s 27.5-year MACRS life.
Land Is Not Depreciable
Land never depreciates. The IRS excludes it because, unlike a building, it doesn’t wear out or become obsolete.3Internal Revenue Service. Publication 527 – Residential Rental Property When you buy a property, the purchase price has to be split between land and building, and only the building portion goes into the depreciation calculation.
The most common allocation uses your local property tax assessment, which typically breaks assessed value into land and improvement components. Buy a property for $500,000 where the assessment attributes 30 percent to land and 70 percent to improvements, and you depreciate $350,000 over the applicable recovery period. An independent appraisal is another accepted method, and it often produces a better result on higher-value properties where the tax assessment lags the market.
When Depreciation Starts and the Mid-Month Convention
The depreciation clock starts when a property is “placed in service,” which the IRS defines as the point when the building is ready and available for its intended use, not when it first collects rent.4Internal Revenue Service. Depreciation Reminders A rental house is placed in service when it’s move-in ready. If it needs major renovations before a tenant can occupy it, the clock doesn’t start until that work is done.
Real property under MACRS follows the mid-month convention. Every property is treated as placed in service on the 15th of the month regardless of the actual closing date. Buy a rental on March 1 or March 28 and you get the same first-year deduction: half a month of March plus the remaining nine months. For a residential rental with a $275,000 depreciable basis, the full-year deduction is $10,000; place it in service in March and the first year is roughly $8,333.
The same rule applies on sale. The month of disposition gives you half a month of depreciation, so selling on September 3 and selling on September 29 produce the same final-year deduction. A January purchase and a December sale each maximize the depreciation captured in a partial year.
Bonus Depreciation After the One Big Beautiful Bill
Section 168(k) provides an additional first-year deduction, commonly called bonus depreciation, for property with a recovery period of 20 years or less. The building shell itself (27.5 or 39 years) never qualifies. Shorter-lived components do: personal property inside the building, land improvements, and qualified improvement property.
The One, Big, Beautiful Bill, signed into law in 2025, restored a permanent 100 percent additional first-year depreciation deduction for qualified property acquired after January 19, 2025.5Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill For real estate investors placing eligible components in service in 2026 or later, the full cost of qualifying components can be deducted in the first year. Taxpayers can instead elect 40 percent bonus depreciation for property placed in service in a tax year ending after January 19, 2025, which is useful when spreading deductions across years produces a better result.
Property acquired on or before January 19, 2025 follows the older phase-down: 80 percent for 2023, 60 percent for 2024, and 40 percent for 2025. Any basis left after bonus depreciation continues to be recovered on the standard MACRS schedule.
The practical effect scales with cost segregation. A $5 million commercial building might contain $1.2 million in components with 15-year or shorter recovery periods. Under the restored 100 percent bonus, that entire $1.2 million can be deducted in year one rather than spread across 5 to 15 years.
Qualified Improvement Property
Qualified improvement property (QIP) is any improvement to the interior of an existing nonresidential building, placed in service after the building itself was first placed in service.6Cornell Law Institute. 26 USC 168(e)(6) – Qualified Improvement Property QIP carries a 15-year recovery period, and it qualifies as 15-year property for bonus depreciation. That combination means interior renovations to a commercial building acquired after January 19, 2025 can be fully expensed in the year they’re completed.
Three categories of work are specifically excluded from QIP and must follow the 39-year nonresidential schedule:
- Building enlargements that increase total square footage.
- Installation or replacement of elevators and escalators.
- Work on the internal structural framework: load-bearing walls, columns, floors, or ceilings.
QIP applies only to nonresidential buildings. Renovations inside an apartment building don’t qualify; they follow the 27.5-year residential rental life.
Section 179 for Roofs, HVAC, and Other Exclusions
Section 179 covers some improvements that fall outside QIP. Under Section 179(f), the following improvements to nonresidential real property can be expensed immediately when placed in service after the building’s original in-service date:7Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets
- Roofs
- Heating, ventilation, and air-conditioning systems
- Fire protection and alarm systems
- Security systems
This matters because a roof replacement is not an interior improvement and doesn’t qualify as QIP. Without Section 179, a $200,000 commercial roof would depreciate over 39 years. With it, the full cost is expensed immediately, subject to the annual cap. For 2026, the maximum Section 179 deduction is approximately $2,560,000, with the phase-out beginning when total qualifying property placed in service exceeds roughly $4,090,000. QIP also qualifies for Section 179, giving commercial owners two routes to accelerated deductions on interior work.
Cost Segregation Studies
A cost segregation study is what actually unlocks the accelerated pieces of Section 168. Without one, the entire building sits in the 27.5- or 39-year bucket. With one, an engineering team breaks the property into its components and reclassifies everything that qualifies for a shorter life: electrical systems dedicated to specific equipment (5-year), decorative finishes and carpeting (5-year), and site improvements like parking lots and landscaping (15-year).
The IRS expects a quality study to be prepared by someone with both engineering and tax expertise.8Internal Revenue Service. Cost Segregation Audit Technique Guide It should include a description of methodology, a legal analysis explaining why each component qualifies for Section 1245 (personal property) treatment, and an engineering take-off that maps components to actual or estimated costs. Documentation is what separates a reclassification the IRS will accept from one it will challenge.
The study relies on detailed construction records: itemized contractor invoices, architectural drawings, and payment applications. When those aren’t available (common with older buildings or lump-sum purchases), engineering firms use standardized costing manuals to estimate component values. Professional fees typically run between $5,000 and $15,000 depending on the property’s size and complexity, though first-year tax savings frequently exceed that cost by ten times or more.
If you’ve owned a property for years without a study, you don’t need to amend prior returns. You file a change in accounting method and take all the missed accelerated depreciation in a single catch-up year, which is often the most valuable move available to an existing owner.
The ADS Trade-Off Under Section 163(j)
Some real estate businesses face a choice that directly changes how Section 168 applies to them. Section 163(j) limits the deduction for business interest expense for most taxpayers. A real property trade or business can elect out of that limitation and deduct all its mortgage interest without restriction. The cost of the election is that the business must depreciate its real property using the Alternative Depreciation System (ADS) instead of the General Depreciation System.9Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
ADS stretches the recovery period to 30 years for residential rental property and 40 years for nonresidential real property, and property depreciated under ADS is not eligible for bonus depreciation. For a highly leveraged property with substantial interest expense, the trade may still be worthwhile. For a property with low debt or strong cost segregation potential, surrendering bonus depreciation can cost more than the interest deduction saves. The election is irrevocable, so the math has to be done before you commit.
Depreciation Recapture When You Sell
Every dollar of depreciation claimed under Section 168 reduces your basis, and the IRS collects that benefit back on sale. Recapture is the tax consequence most investors underestimate, and it applies even if you never actually claimed the deductions.
For the building itself (Section 1250 property), gain attributable to straight-line depreciation is taxed as “unrecaptured Section 1250 gain” at a maximum federal rate of 25 percent. That sits between ordinary income rates and long-term capital gains rates, and it applies on top of capital gains tax on any appreciation above the property’s original cost.
For personal property and land improvements reclassified through a cost segregation study (Section 1245 property), recapture is worse. Depreciation on those components comes back at ordinary income rates, which can reach 37 percent. That is the trade-off built into accelerated depreciation: larger deductions upfront, higher recapture on the components that produced them.
The IRS applies an “allowed or allowable” rule, which means your basis is reduced by the depreciation you should have taken, not just what you actually claimed.10Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets If you owned a rental for ten years and never claimed a dollar of depreciation, the IRS still treats your basis as if you had. Skipping the deduction doesn’t avoid recapture. It just means you paid more tax along the way and still owe the same amount at the end. Always claim it.
Reporting Depreciation and Catching Up
Depreciation is reported on IRS Form 4562 (Depreciation and Amortization), filed with your income tax return for the year the property is placed in service and any year new improvements are added.11Internal Revenue Service. About Form 4562, Depreciation and Amortization The form requires each asset’s cost basis, recovery period, method, and convention. Buildings, land improvements, and personal property identified through cost segregation get separate lines.
If you discover unclaimed depreciation from prior years, you don’t have to amend each return. You file IRS Form 3115 (Application for Change in Accounting Method) with your current-year return.12Internal Revenue Service. About Form 3115, Application for Change in Accounting Method That triggers a Section 481(a) adjustment, which pulls all the missed depreciation into a single tax year. Under the automatic consent procedures, no advance IRS approval is needed.13Internal Revenue Service. Revenue Procedure 2025-23 For an investor who bought a commercial building five years ago without a cost segregation study, this procedure can generate a six-figure deduction in the current year.