Residential rental property has a depreciation life of 27.5 years under the Modified Accelerated Cost Recovery System. You take the depreciable value of the building, divide it by 27.5, and deduct that amount every year against your rental income. The method is straight-line, so the deduction is the same each full year you own the property.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Straight Line Method No cash leaves your pocket, which is why depreciation is the most valuable tax benefit of owning a rental.
What Qualifies for the 27.5-Year Schedule
A building gets the 27.5-year life only if at least 80 percent of its gross rental income comes from dwelling units.2Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Residential Rental Property Single-family houses, duplexes, apartment buildings, and rented condominiums all clear that bar easily. A mixed-use building with a ground-floor shop can still qualify as long as the residential rents produce at least 80 percent of the revenue.
If a property falls below the 80 percent threshold, it is nonresidential real property and depreciates over 39 years instead.3Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System The classification matters, because 39 years produces a noticeably smaller annual deduction on the same cost.
Figuring Your Depreciable Basis
Before you can divide by 27.5, you need the right number on top. Depreciable basis is your purchase price plus allowable closing costs and any capital expenditures made before the property is ready to rent. From that total, you subtract land. Land never depreciates because it doesn’t wear out or become obsolete.4Internal Revenue Service. Topic No. 704, Depreciation
Say you buy a rental for $350,000 and the land under it is worth $75,000. Your depreciable basis is $275,000, and your annual deduction is $275,000 divided by 27.5, or $10,000. Overstating the building portion inflates your deduction and invites IRS scrutiny, so the split has to be defensible.
Splitting Land From Building
The simplest method is to use the ratio from your local property tax assessment. If the assessment attributes 25 percent of value to land, apply that same 25 percent to your actual purchase price. A professional appraisal as of your purchase date is more defensible if the IRS ever asks; those run roughly $1,000 to $6,000 depending on the property.
Converting a Home You Lived In
When you turn a personal residence into a rental, you don’t automatically use what you paid. Your depreciable basis is the lower of your adjusted basis in the property or its fair market value on the date of conversion.5Internal Revenue Service. Publication 527 – Residential Rental Property Bought for $300,000, worth $260,000 when you rent it out? You depreciate the $260,000 figure (minus land). The drop in value doesn’t become a depreciation deduction.
Inherited Rental Property
Inherited property generally takes a stepped-up basis equal to fair market value on the date of the previous owner’s death. You start a fresh 27.5-year clock on that higher figure, still subtracting the land portion first.
How the Annual Calculation Works
Residential rental buildings must use straight-line depreciation.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Straight Line Method No accelerated method is available for the structure itself. Divide the depreciable basis by 27.5 and that is your deduction for each full year of ownership.
The first and last years are prorated under the mid-month convention.6Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Mid-Month Convention The property is treated as placed in service at the midpoint of whatever month it becomes available for rent, regardless of when a tenant actually moves in. Place a property in service in November and you get one and a half months of depreciation that year. Sell in July and you claim six and a half months for the final year.
You report the deduction on Form 4562, Depreciation and Amortization.7Internal Revenue Service. Instructions for Form 4562 The total then flows to Schedule E, where it reduces net rental income.8Internal Revenue Service. Schedule E (Form 1040) – Supplemental Income and Loss
Items That Don’t Belong on the 27.5-Year Schedule
The 27.5-year life applies to the building and its permanent components. Plenty of things inside or around the property have shorter lives under other MACRS classes:
- 5-year property: appliances, carpeting, and window treatments.
- 7-year property: office furniture and equipment used to manage the rental.
- 15-year property: land improvements like fences, driveways, sidewalks, and septic systems.
The faster schedules are worth the effort to break out.5Internal Revenue Service. Publication 527 – Residential Rental Property A $3,000 refrigerator over 5 years gives you $600 a year. Bury the same $3,000 in the building’s 27.5-year total and it produces only about $109 per year.
Later capital improvements that add value or extend the building’s life, such as a new roof or a full HVAC replacement, generally start their own 27.5-year schedule from the date the work is completed.9Internal Revenue Service. Depreciation and Recapture 4 Each improvement runs on its own clock, independent of the original building.
Cost Segregation Studies
A cost segregation study is an engineering analysis that pulls components out of the 27.5-year bucket and reclassifies them into the 5-, 7-, or 15-year categories. Specialized electrical work, decorative finishes, and certain plumbing can often be moved. The studies typically run $5,000 to $15,000 for a single-family rental, so they usually pay off only on higher-value properties.
Depreciation Recapture When You Sell
Depreciation reduces your tax every year you own the property, and the IRS takes a portion back when you sell at a gain. The total depreciation you claimed over your ownership period is taxed as unrecaptured Section 1250 gain at a maximum federal rate of 25 percent.10Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed Gain above the recaptured amount is taxed at the lower long-term capital gains rates.
One trap catches new landlords who try to skip depreciation and avoid the recapture. The IRS reduces your basis by depreciation “allowed or allowable,” meaning the amount you were entitled to deduct whether or not you actually took it.11Internal Revenue Service. Depreciation and Recapture 3 Skipping the deduction saves you nothing at sale; it just means you paid more tax along the way for no benefit. Recapture is reported on Form 4797, Sales of Business Property.12Internal Revenue Service. Instructions for Form 4797 – Sales of Business Property