TAX

How Depreciation Actually Works on Rental Properties

Updated March 2026

The Basic Concept

The IRS says residential rental buildings wear out over 27.5 years. So they let you deduct 1/27.5th of the building's value each year as a 'paper loss' — even while the property is actually appreciating. Buy a $180K property where the building (not land) is worth $144K, and you get a $5,236 annual deduction. If you're in the 24% tax bracket, that saves you $1,257/year in real taxes. On a property generating $3,600 in cash flow, depreciation shelters more than a third of it from taxes.

Land vs. Building Split

You can only depreciate the building, not the land. Most investors use the tax assessor's allocation — if the assessor says 80% building, 20% land, use that split. Some investors get an appraisal to justify a higher building percentage. On a $200K property, the difference between 70% building ($140K) and 85% building ($170K) is an extra $1,091/year in depreciation deductions.

Cost Segregation

A cost segregation study reclassifies building components into shorter depreciation schedules. Appliances, carpeting, and certain fixtures become 5-year property. Landscaping and parking become 15-year property. On a $200K property, a cost seg study might front-load $30-40K of deductions into the first 5 years instead of spreading them over 27.5. The study costs $3-5K but can generate $8-15K in first-year deductions. Usually worth it on properties above $150K.

Depreciation Recapture

When you sell, the IRS recaptures the depreciation you claimed — taxed at 25%. If you claimed $30K in depreciation and sell at a profit, you owe 25% on that $30K ($7,500) in addition to capital gains. The way to avoid this: do a 1031 exchange into another property, deferring both capital gains and depreciation recapture.