What Is Depreciation in Real Estate and How Does It Work?

Real estate depreciation is a federal income tax deduction that lets you recover the cost of a building you use for business or rental purposes by writing off a portion of its value each year over a fixed recovery period. The IRS treats buildings as assets that wear out, so it spreads your investment across 27.5 years for residential rental property and 39 years for nonresidential real property. You get the deduction without spending any new money, and it reduces taxable income every year you own the property. Land is not included because it doesn’t wear out.

Who Can Claim It

Three conditions have to be met under Internal Revenue Code Section 167. You must own the property, you must use it in a trade or business or hold it to produce income, and it must have a determinable useful life longer than one year.¹

A home you live in doesn’t qualify. Convert that home into a rental and depreciation starts on the date you place it in service as a rental; move back in later and depreciation stops on the conversion date. A vacant unit still qualifies while you’re actively marketing it for rent, but the deductions end once you stop offering it.²

What Goes Into Your Depreciable Basis

Your depreciable basis is the number you actually spread across the recovery period. Start with the purchase price, then add closing costs that get capitalized rather than expensed: recording fees, title insurance, legal fees, transfer taxes, survey costs, charges for installing utility services, and any seller obligations you agreed to pay.³

Then separate out the land. Most investors use their county’s property tax assessment, which splits assessed value between land and improvements. If the assessor puts 20% on land, apply that ratio to your total price. On a $500,000 purchase, the building’s depreciable basis is $400,000. A professional appraisal is an alternative when the assessor’s ratio doesn’t reflect the market.

Inherited Property

Inherit a rental and the basis resets to the property’s fair market value on the date the prior owner died. A rental originally purchased for $120,000 that’s worth $450,000 at death gives you a $450,000 starting point (less land). Any depreciation the previous owner claimed drops out of the equation, and you begin a new recovery period against the stepped-up value.

How Long You Depreciate a Building

Under the Modified Accelerated Cost Recovery System (MACRS), buildings fall into two main classes:⁴

Residential rental property: 27.5 years. A building qualifies when at least 80% of gross rental income comes from dwelling units. That covers apartment buildings and single-family rentals.
Nonresidential real property: 39 years. Office buildings, warehouses, retail, and anything that misses the residential threshold.

Not every component of a property runs on the long clock. Land improvements such as fences, sidewalks, roads, and landscaping use a 15-year period. Qualified improvement property, meaning interior work on nonresidential buildings done after the building is placed in service, is also 15-year property. Appliances, carpet, and furniture in a residential rental are 5-year property, and office furniture and fixtures are 7-year property.⁵

Calculating the Annual Deduction

Real estate uses the straight-line method. Divide the depreciable basis by the recovery period and that’s the full-year deduction. A residential rental with a $275,000 building basis produces $10,000 per year ($275,000 ÷ 27.5).⁵

The first and last years are partial. The IRS applies a mid-month convention: the property is treated as placed in service at the midpoint of the month you actually start using it. A nonresidential property placed in service in January generates 11.5 months of depreciation for year one; place it in service in October and you get 2.5 months. The same half-month applies in the month you sell.

Placed in service means ready and available for its intended use, not the day you closed. Buy a rental in March, spend two months renovating, list it in May, and the placed-in-service date is when it became available to rent.

Why Skipping the Deduction Backfires

Some owners think they can avoid trouble at sale by never claiming depreciation. It doesn’t work. The IRS applies an “allowed or allowable” rule, which reduces your basis at sale by the depreciation you were entitled to take whether you claimed it or not.⁵ Skip the deduction and you still owe recapture on the full amount you could have claimed. That’s no annual tax benefit during ownership and the same tax bill at sale. Claim it.

Repairs vs Improvements

Not every dollar you put into a property after purchase is a current-year expense. Routine maintenance and minor fixes that keep the property in its current condition are deductible in the year you pay them. Improvements have to be capitalized and depreciated as separate assets.

A cost is an improvement if it does any of the following:²

Betterment. Fixes a pre-existing defect, enlarges the property, or increases its capacity or quality.
Restoration. Replaces a major structural component, repairs casualty damage after a basis adjustment, or rebuilds to like-new condition.
Adaptation. Changes the property to a use different from its original intended purpose.

Replacing an entire roof is capitalized. Patching a few shingles is a repair. Each capitalized improvement has its own placed-in-service date and its own recovery period.

Limits on Using Rental Losses

Rental activity is passive for most taxpayers. Rental losses, including losses created by depreciation, can normally only offset other passive income. They don’t reduce your wages or investment earnings in the current year. Unused losses carry forward and become fully deductible when you sell the property in a taxable transaction.

Active participants get a partial break. If you make real management decisions like approving tenants, setting rent, and authorizing repairs, you can deduct up to $25,000 in rental losses against non-passive income each year. That allowance phases out between $100,000 and $150,000 of modified adjusted gross income.⁶

Real Estate Professional Status

Qualifying as a real estate professional removes the passive limitation entirely. You have to meet both tests in the same year:⁶

More than half of your total personal services for the year are in real property trades or businesses in which you materially participate.
More than 750 hours of those services are performed during the year.

Hours worked as an employee in real estate don’t count unless you own at least 5% of the employer. You also have to materially participate in each rental activity you want treated as non-passive, generally by logging more than 500 hours in it. The IRS scrutinizes these claims, so contemporaneous records matter.

Where It Goes on Your Tax Return

Individual rental owners report depreciation on Schedule E (Form 1040), line 18, for each property. If you placed new depreciable property in service during the year or you’re claiming a special depreciation allowance, attach Form 4562.² A separate Form 4562 is required for each business or activity that needs one.⁷ Once a property is established and no new assets are placed in service, preparers typically continue the depreciation on Schedule E without a new Form 4562 each year.

Speeding It Up: Cost Segregation, Bonus Depreciation, and Section 179

A cost segregation study uses an engineering analysis to reclassify pieces of a building into the shorter 5-, 7-, and 15-year classes. The structural shell stays on 27.5 or 39 years, but appliances, carpeting, certain electrical and plumbing, land improvements, and qualified interior improvements move to shorter schedules and produce much larger deductions in the early years.⁵ The study itself is a deductible expense.

The One, Big, Beautiful Bill Act restored 100% bonus depreciation permanently for qualified property acquired after January 19, 2025. It applies to tangible property with a MACRS recovery period of 20 years or less, which picks up the 5-, 7-, and 15-year components a cost segregation study identifies, but not the building shell.⁸ Qualified improvement property, sitting in the 15-year class, is eligible for full first-year expensing.

Section 179 lets you expense the full cost of certain qualifying property in the year it’s placed in service. For 2026 the maximum deduction is $2,560,000, with a phase-out beginning at $4,090,000 of total qualifying property placed in service. For real property, Section 179 is limited to nonresidential buildings and covers roofs, HVAC, fire alarm and protection systems, and security systems.⁹ Residential rental components don’t qualify.

What Happens When You Sell

Sell for more than your depreciated basis and part of the gain is taxed at a higher rate than the ordinary long-term capital gains rate. That portion is called unrecaptured Section 1250 gain, and it’s taxed at a maximum of 25%.

Here’s the math. You bought a residential rental with a $400,000 building basis (after removing land), claimed $100,000 in total depreciation, and your adjusted basis is $300,000. You sell for $500,000. Total gain is $200,000. The first $100,000, matching your cumulative depreciation, is taxed at up to 25%. The remaining $100,000 is taxed at your regular long-term capital gains rate, which tops out at 20% for most investors.¹⁰ The “allowed or allowable” rule still applies at sale: recapture is calculated on what you could have deducted, not just what you did.

Partial Disposition When You Replace a Component

When you replace a major building component such as a roof, HVAC system, or plumbing, you can make a partial disposition election. That lets you write off the remaining undepreciated basis of the old component as a loss in the year of replacement, instead of continuing to depreciate something that no longer exists. The new component then starts its own schedule. Without the election, you effectively depreciate two roofs on one building.

Deferring Everything With a 1031 Exchange

A like-kind exchange under IRC Section 1031 lets you sell investment real estate, reinvest the proceeds in replacement real property, and defer all the gain, including depreciation recapture. Both the relinquished and replacement properties must be real property held for business or investment. Personal property, stocks, and partnership interests don’t qualify.¹¹

Two deadlines run at once. You have 45 days from the sale of the relinquished property to identify potential replacements in writing, and 180 days (or your tax return due date, whichever is earlier) to close on the replacement. Miss either and the entire gain becomes taxable.¹¹ Deferral is not forgiveness. Accumulated depreciation carries over into the basis of the new property, and when you eventually sell without another exchange, the deferred recapture comes due.

1
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
4
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
6
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
7
Internal Revenue Service. Instructions for Form 4562 (2025)
8
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
9
Internal Revenue Service. Depreciation Expense Helps Business Owners Keep More Money
10
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
11
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031