Schedule E Depreciation: Basis, Recovery Periods, and Recapture

Schedule E depreciation is the annual deduction that lets you recover the cost of a rental building over 27.5 years for residential property (39 years for commercial), calculated on Form 4562 and carried to Line 18 of Schedule E (Form 1040), where it reduces your rental income alongside mortgage interest, taxes, and repairs.¹ You never write a check for it, but the IRS still tracks it, and every dollar you claim (or should have claimed) comes back into your taxable gain when you sell.

When the Clock Starts

Depreciation does not begin at closing. It begins when the property is “placed in service,” meaning it is ready and available for rent. Buy a house in April, fix it up through June, list it in July: depreciation starts in July.² You do not need a signed lease. Advertising a rentable unit is enough.

Once it starts, depreciation runs every year until you have recovered your full basis or you pull the property out of rental use.² Vacancy between tenants does not stop the clock, so long as you are actively trying to rent. Converting the property to personal use or selling it does.

Figuring Your Depreciable Basis

Your depreciable basis is the dollar amount you get to recover through those annual deductions. Start with the total acquisition cost: purchase price plus settlement charges you paid as buyer, including legal fees, title insurance, survey, recording fees, and transfer taxes.³

Then split that total between land and building. Land does not depreciate.⁴ Only the structure, its built-in systems, and fixtures generate a deduction. The most common allocation method is the ratio from your county property tax assessment. If the assessor puts 20% of value on land and 80% on improvements, apply that same 80/20 to your acquisition cost.³ An independent appraisal is a fine alternative, particularly when the assessor’s split looks off. Keep the closing statement and whatever supports your allocation. The IRS can challenge it.

Inherited Property

If you inherited the rental, ignore the prior owner’s purchase price. Under IRC §1014, your basis is generally the fair market value on the date the prior owner died.⁵ Split that stepped-up value between land and building, then start a fresh 27.5-year schedule from your placed-in-service date. Whatever the decedent depreciated is irrelevant to you.

Improvements Versus Repairs

Every capital improvement you make after the property is in service becomes its own depreciable asset with its own schedule and placed-in-service date. New roof, full HVAC replacement, converting a garage into a rentable unit: those add value, extend life, or adapt use.⁴

Ordinary repairs are fully deductible in the year you pay them. Patching a section of roof, fixing a leaking faucet, repainting a unit between tenants: operating expenses, not capital improvements.⁶ The routine maintenance safe harbor treats an activity as a deductible repair if you expect to perform it more than once in a 10-year window to keep the building in normal operating condition.

There is also a de minimis safe harbor. Without audited financial statements, which most individual landlords lack, you can expense purchases of $2,500 or less per invoice rather than depreciating them. With audited statements, the threshold is $5,000.⁶ You elect it each year with a statement attached to your return.

Recovery Periods and the Mid-Month Convention

For any rental placed in service after 1986, federal law requires the Modified Accelerated Cost Recovery System (MACRS).² MACRS controls the recovery period, the method, and how partial years get handled.

Residential rental property runs 27.5 years, straight-line. A building qualifies as residential when at least 80% of its gross rental income comes from dwelling units. Apartments, single-family homes, duplexes, and mobile homes all count.² Hotels and motels with more than half their units on short-term transient rental do not.

Nonresidential rental property runs 39 years, also straight-line.⁴ Office space, retail, warehouse, or any building that misses the 80% residential test lands here. Applying 27.5 years to a building that should use 39 overstates the deduction every year and is one of the more expensive classification errors landlords make.

Both categories use a mid-month convention. Whatever day of the month you place the property in service, the IRS treats it as mid-month.² A January placed-in-service date gets 11.5 months in year one; a December date gets half a month. The same rule applies in the year of sale.

The Alternative Depreciation System (ADS) is a longer, slower schedule required in specific circumstances (property used by tax-exempt entities, property used predominantly outside the United States, and real property businesses electing out of the §163(j) interest limitation). Under ADS, residential rental placed in service after December 31, 2017, uses a 30-year period.⁷ For most individual landlords, the standard 27.5-year path produces the larger annual deduction.

Shorter-Life Components and Bonus Depreciation

Not everything inside a rental depreciates over 27.5 years. Certain personal property and land improvements have much shorter MACRS lives:

5-year property: appliances (stoves, refrigerators, dishwashers), carpeting, and furniture used in rental units.²
7-year property: office furniture and equipment not otherwise classified.
15-year property: land improvements such as roads, fences, driveways, walkways, and shrubbery.²

Pulling these items out of the 27.5-year bucket is what a cost segregation study does. An engineering firm walks the building, identifies every component eligible for a shorter recovery period, and reallocates basis. On a $400,000 building, reclassifying $60,000 to $100,000 of assets into the 5-, 7-, and 15-year classes is common.

The reason to bother is bonus depreciation. Under IRC §168(k), property with a recovery period of 20 years or less that is acquired and placed in service after January 19, 2025, qualifies for 100% bonus depreciation. Components identified in a cost segregation study (appliances, carpet, fencing, paving) can be written off entirely in year one instead of stretched over 5 or 15 years. The 27.5-year shell itself does not qualify, but the short-life components do. Combined, cost segregation plus bonus depreciation can produce a very large first-year deduction on a newly acquired rental.

Doing the Math on Form 4562

Form 4562, Depreciation and Amortization, is where you document the numbers. File it any year you place a new depreciable asset in service or claim depreciation.⁸ Real property lives in Part III: residential rental on line 19g (27.5-year), nonresidential on line 19h (39-year).⁹ Each asset gets its own line with placed-in-service date, depreciable basis, recovery period, method, convention, and the deduction.

The calculation is straightforward. Multiply the depreciable basis by the MACRS table percentage for the month placed in service and the recovery year. The percentages, published in Publication 946, already bake in the straight-line method and the mid-month convention. A $400,000 residential basis placed in service in January produces a first-year deduction of $13,940 ($400,000 × 3.485%). The same basis placed in service in June yields $7,880 in year one ($400,000 × 1.970%). In each full year after that, the factor is 3.636%, for a steady $14,544 annual deduction on a $400,000 basis.²

Two details that trip people up. You always apply the table percentage to the original basis, never a declining balance. And you always use the table for the year the property was placed in service, not the current tax year.

If your property has capital improvements layered on top of the original building, each improvement is a separate line on Form 4562 with its own placed-in-service date, basis, and factor. All MACRS deductions total on line 22 of Form 4562, and that total is what moves to Schedule E.⁹ Keep a running depreciation schedule for every asset: original cost, method, recovery period, deduction claimed each year. Software builds these automatically, but if you switch preparers you need to carry them forward accurately. A missing schedule creates problems at audit and again at sale.

Where It Lands on Schedule E

The Form 4562 total goes on Line 18 of Schedule E (Form 1040), Part I, labeled “Depreciation expense or depletion.”¹⁰ Schedule E has a separate column per property, and each column gets its own Line 18.

Depreciation combines with your other rental expenses (mortgage interest, property taxes, insurance, repairs, management fees) and subtracts from gross rental income to produce net profit or loss per property. Because depreciation is a non-cash expense, it often turns a cash-positive rental into a paper loss for tax purposes. That paper loss is the whole point of the deduction. Whether you can actually use it against your other income is a separate question.

Whether You Can Actually Use the Loss

Rental real estate is a passive activity for most taxpayers. Losses from it, including the losses generated by depreciation, ordinarily offset only other passive income.¹¹ Without passive income to soak them up, the losses suspend and carry forward.

The main exception is the $25,000 special allowance under IRC §469. If you actively participate in managing the rental (approving tenants, setting rent, authorizing repairs), you can deduct up to $25,000 of rental losses against wages or other non-passive income.¹² Active participation is a lower bar than material participation. You do not need to work full-time as a landlord.

The $25,000 allowance phases out at 50 cents on the dollar once modified AGI passes $100,000, disappearing entirely at $150,000.¹¹ Married taxpayers filing separately who lived together at any point during the year get a $12,500 ceiling with the phase-out starting at $50,000. This is where a lot of landlords first realize their depreciation deduction is being suspended rather than used.

Suspended losses are not lost. They carry forward and offset future passive income. When you sell the property in a fully taxable transaction, every remaining suspended loss releases and offsets the gain.

Fixing Depreciation You Missed

If you forgot to depreciate in prior years, or a previous preparer skipped it, the fix is not to amend old returns. File Form 3115, Application for Change in Accounting Method, with your current-year return.¹³ It requests a change from an impermissible method (not depreciating) to the correct one.

The IRS treats this as an automatic change in most cases. No advance approval, no user fee. You total the depreciation you should have claimed across all prior years, subtract anything you actually claimed, and the difference is your Section 481(a) adjustment. When that adjustment is negative, and it will be when you missed deductions, the whole amount is deductible on the return for the year of change. Ten years of missed depreciation can land on a single return.

Fix it because of the “allowed or allowable” rule. When you sell, the IRS reduces your basis by the depreciation you were entitled to claim, whether or not you actually claimed it.¹⁴ Skipping depreciation does not save you from recapture. It just means you paid more income tax along the way for nothing. There is no time limit on filing Form 3115 as long as you still own the property.

Recapture at Sale

Every dollar of depreciation you claimed (or could have claimed) reduces your adjusted basis. Lower basis, larger taxable gain. That is depreciation recapture, and it is the trade-off for years of paper deductions.

The portion of gain attributable to prior depreciation is “unrecaptured Section 1250 gain,” taxed at a maximum federal rate of 25%.¹⁵ Any additional gain above your original cost basis is taxed at long-term capital gains rates of 0%, 15%, or 20% depending on income. The recapture calculation lives in Part III of Form 4797, Sales of Business Property.¹⁶

A simplified example. You bought a residential rental for $500,000, allocated $400,000 to the building, and claimed $100,000 of depreciation over the years. Your adjusted basis is $400,000. Sell for $600,000, and the total gain is $200,000. The first $100,000 (the recaptured depreciation) is taxed at up to 25%. The remaining $100,000 is taxed at long-term capital gains rates. State income tax may add another layer.

A Section 1031 like-kind exchange defers both the recapture and the capital gain if you roll into another investment property rather than cashing out.¹⁷ The depreciation is not forgiven. It carries into the replacement property and comes due when you eventually sell without exchanging. Heirs who inherit the property receive a stepped-up basis under §1014, which wipes out the accumulated recapture entirely.

Your State Return May Not Match

Federal depreciation does not always flow cleanly to your state return. Fewer than half of the states with an income tax fully conform to federal MACRS. Many states have decoupled from bonus depreciation, some require different recovery periods, and at least one runs an entirely separate depreciation system. If you claim bonus depreciation or run a cost segregation study for federal purposes, check whether your state requires an add-back and a separate state depreciation schedule.

1
Internal Revenue Service. Tips on Rental Real Estate Income, Deductions and Recordkeeping
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
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Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
5
Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent
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Internal Revenue Service. Tangible Property Regulations – Frequently Asked Questions
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Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
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Internal Revenue Service. About Form 4562, Depreciation and Amortization
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IRS.gov. Instructions for Form 4562
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Internal Revenue Service. Instructions for Schedule E (Form 1040)
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Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
12
Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited
13
Internal Revenue Service. Instructions for Form 3115
14
Internal Revenue Service. Depreciation and Recapture
15
Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed
16
Internal Revenue Service. 2025 Instructions for Form 4797 – Sales of Business Property
17
Office of the Law Revision Counsel. 26 U.S.C. 1031 – Exchange of Real Property Held for Productive Use or Investment