What depreciation is, and why it is the best deduction a landlord gets
Depreciation lets you deduct the cost of a rental building against your rental income over its recovery period, on the theory that the structure wears out. It is unlike every other deduction on a rental schedule in one respect: you take it without spending anything. The mortgage interest, the insurance, the roof repair — all of those require you to write a cheque in the year you deduct them. Depreciation is a deduction for money you spent once, years ago, and often mostly with borrowed funds.
That is why a rental can produce positive cash flow and a tax loss in the same year. On the worked example below, a $284,800 depreciable basis produces a $10,356 annual deduction. A property throwing off $9,000 of cash after every real expense shows a $1,356 loss on paper, and the owner banks the cash while reporting a loss.
Three decisions determine the number, and the arithmetic afterwards is trivial:
How much is land? Land never depreciates, so it must be separated out. This is the single largest lever and the one most often handled carelessly.
Which recovery period? Residential rental property recovers over 27.5 years under the general depreciation system; nonresidential real property over 39 years. Residential treatment requires at least 80% of gross rental income to come from dwelling units.
When was it placed in service? Real property uses the mid-month convention, so the property is treated as placed in service in the middle of whatever month it actually was, and the first year is prorated accordingly.
Land allocation and the mid-month convention
Land allocation is a factual question with a documented answer, not a guess. The most commonly used method is the county assessor's ratio: if the assessment shows land at $70,000 and total at $350,000, land is 20% and you apply that percentage to your actual acquisition cost. An appraisal that separately values the site is stronger evidence, and on an unusual property it is worth having. What you should not do is pick a low land percentage because it produces a bigger deduction — the allocation is reviewable, and it also sets your basis for the eventual sale.
The right share varies enormously with location. A condominium unit may carry very little land. A single-family house on a large urban lot may be mostly land. Whatever the number, capture the evidence at the time of purchase and keep it with the closing file.
The mid-month convention means real property is always treated as placed in service in the middle of its actual month, regardless of the day. Property first available to rent on 3 June and property first available on 27 June both get the same first-year treatment: six and a half months of the year remain, so the first-year deduction is the full-year amount times 6.5 ÷ 12.
The general formula for the months allowed in year one is 12.5 − month number. January gives 11.5 months, June gives 6.5, December gives 0.5. Divide by twelve and by the recovery period and you have the first-year percentage: for a 27.5-year residential property placed in service in January, 11.5 ÷ 12 ÷ 27.5 = 3.485% of basis, which is the published first-year rate.
Nothing is lost to the convention. Whatever the first year does not take, the final year takes, which is why the schedule always spills into one extra calendar year: a 27.5-year residential schedule spans 28 calendar years for property placed in service January through June, and 29 years for July through December. In every case the deductions sum to exactly the depreciable basis.
One point of timing is worth emphasising: placed in service means ready and available to rent, not the closing date and not the date a tenant moves in. A house bought in March and made rent-ready in May is placed in service in May, even if the first lease starts in July.
Worked example: a $350,000 duplex placed in service in June
You buy a duplex for $350,000 and capitalise $6,000 of title, legal and recording costs into basis. The county assessment shows land at 20% of total value. The property is rent-ready in June. Your combined federal and state marginal rate is 24%.
- Acquisition cost. $350,000 + $6,000 = $356,000.
- Land. 20% × $356,000 = $71,200 — excluded permanently.
- Depreciable basis. $356,000 − $71,200 = $284,800.
- Recovery period. Residential rental, so 27.5 years.
- Full-year deduction. $284,800 ÷ 27.5 = $10,356.36.
- First-year months. 12.5 − 6 = 6.5 months.
- First-year deduction. $10,356.36 × 6.5 ÷ 12 = $10,356.36 × 0.541667 = $5,609.70.
- First-year rate. $5,609.70 ÷ $284,800 = 1.970% of basis, which is 6.5 ÷ 330.
- Annual tax saving. 24% × $10,356.36 = $2,485.53.
- First-year tax saving. 24% × $5,609.70 = $1,346.33.
Over the whole schedule you deduct the entire $284,800 — nothing more, nothing less. At a constant 24% rate that is $68,352 of tax deferred. A June placement fills 6.5 months in year one, twenty-six full years, and 11.5 months in year twenty-eight: 6.5 + 312 + 11.5 = 330 months, which is exactly 27.5 years. The word deferred matters: every dollar of depreciation reduces your basis, so it comes back as unrecaptured Section 1250 gain when you sell.
What the deduction is really worth
Depreciation is a deferral, not forgiveness. Each dollar you deduct reduces your adjusted basis by a dollar, so it increases the gain on eventual sale by the same amount. That gain is taxed as unrecaptured Section 1250 gain at a federal rate of up to 25%. If you deduct at a 24% marginal rate and recapture at 25%, the headline arithmetic is close to a wash — the benefit is the time value of money over the years in between, which on a long hold is substantial.
Two situations turn the deferral into something better. If you hold until death, the property generally receives a stepped-up basis and the recapture disappears. And a 1031 exchange into a replacement property defers the recapture along with the rest of the gain.
Depreciation is not optional. On sale, your basis is reduced by depreciation allowed or allowable — meaning the deduction you should have taken counts against you whether or not you actually claimed it. Skipping depreciation therefore gives up the deduction and keeps the tax. If you have missed years, the correction is a change of accounting method rather than amended returns, and it is a matter for a tax professional.
The deduction may not be usable immediately. Rental losses are generally passive, and passive losses can usually only offset passive income. A special allowance lets some taxpayers deduct a limited amount of rental loss against ordinary income, but it phases out as income rises. Suspended losses are not lost — they carry forward and are generally released when you dispose of the property. Whether you can use this year's deduction this year is a question about your whole return, not about the property.
Cost segregation can accelerate part of it. An engineering study reclassifies components — appliances, carpet, cabinetry, site improvements — into 5-, 7- and 15-year property that depreciates far faster than the building shell. On a large property the front-loading is worth real money; on a small single-family rental the study often costs more than it saves. It also increases recapture on the accelerated components when you sell.
First-year deduction by month placed in service, 27.5-year property
| Month placed in service | Months allowed | First-year rate | On a $275,000 basis |
|---|---|---|---|
| January | 11.5 | 3.485% | $9,583.33 |
| February | 10.5 | 3.182% | $8,750.00 |
| March | 9.5 | 2.879% | $7,916.67 |
| April | 8.5 | 2.576% | $7,083.33 |
| May | 7.5 | 2.273% | $6,250.00 |
| June | 6.5 | 1.970% | $5,416.67 |
| July | 5.5 | 1.667% | $4,583.33 |
| August | 4.5 | 1.364% | $3,750.00 |
| September | 3.5 | 1.061% | $2,916.67 |
| October | 2.5 | 0.758% | $2,083.33 |
| November | 1.5 | 0.455% | $1,250.00 |
| December | 0.5 | 0.152% | $416.67 |
Every full year in between takes 1 ÷ 27.5 = 3.636% of basis. Whatever the first year does not take, the final year does, so the schedule always totals exactly the depreciable basis.
Which system and period apply
This calculator applies the general depreciation system (GDS) under MACRS, with straight-line recovery and the mid-month convention: 27.5 years for residential rental property and 39 years for nonresidential real property. Those are the periods that apply to most rentals.
Some property must instead use the alternative depreciation system (ADS), which uses longer periods — 30 years for residential rental property placed in service after 2017, and 40 years for nonresidential. ADS is required for property predominantly used outside the United States, tax-exempt use property, and by an electing real property trade or business that has opted out of the business interest limitation, among other cases. If any of that describes your holding, the periods on this page do not apply.
Land improvements with a determinable life — fencing, paving, landscaping installed as part of a site — are 15-year property rather than part of the building, and personal property inside a rental such as appliances and carpet is generally 5-year property. Both depreciate faster than the shell and are outside this calculator's schedule.
Mistakes that cost real money
- Depreciating the whole purchase price. Land never depreciates. Allocating nothing to it overstates every year's deduction and is the first thing an examiner looks at.
- Guessing the land share. Use the assessor's ratio or an appraisal, and keep the document. The allocation also fixes your basis for the eventual sale.
- Using the closing date as the placed-in-service date. The clock starts when the property is ready and available to rent, which may be months later.
- Applying the mid-year convention. Real property uses mid-month. Using half a year in year one is wrong in either direction depending on the month.
- Deducting improvements as repairs. A new roof is capital and depreciates; patching a roof is a repair and deducts immediately. The distinction is worth years of timing.
- Starting later improvements on the building's schedule. Work placed in service in a later year begins its own 27.5-year recovery from that year, with its own mid-month proration.
- Skipping depreciation to avoid recapture. Basis is reduced by depreciation allowed or allowable, so you pay the recapture regardless. Skipping it forfeits the deduction and keeps the tax.
- Forgetting that the deduction may be suspended. Passive loss rules can defer the benefit to a later year or to the year of sale.
How depreciation fits the rest of the rental analysis
Depreciation sits between two different sets of numbers and does not belong in either without care. It is not an operating expense: net operating income is computed before depreciation and before financing, which is why the NOI calculator and the cap rate calculator exclude it entirely. Including it would understate the property's value. It is also not a cash outflow, so it never appears in the cash flow calculator either.
Where it belongs is the tax line. Taxable rental income is cash rent minus operating expenses minus mortgage interest minus depreciation — a different calculation from cash flow, which subtracts the whole mortgage payment including principal and no depreciation at all. The gap between those two figures is what lets a property distribute cash while reporting a loss, and it is the main reason rental after-tax return exceeds pre-tax return in the early years. The rental property ROI calculator puts the whole picture together.
At the exit, everything you claimed here comes back. The depreciation recapture calculator computes the unrecaptured Section 1250 gain, and the capital gains calculator handles the rest of the gain — including the point that a property which was both a residence and a rental gets no Section 121 relief on the depreciation portion.
This page implements the general rules for ordinary rental real estate. Depreciation interacts with passive activity limits, at-risk rules, the qualified business income deduction, the business interest limitation and cost segregation in ways no calculator can capture. Take professional advice before relying on any of it.