Key takeaways
- Only the building depreciates — land never does, so allocation between them matters.
- Residential rental property depreciates over 27.5 years; commercial over 39.
- Cost segregation reclassifies components into 5, 7, and 15-year lives, accelerating deductions.
- Depreciation is recaptured at sale at rates up to 25%, whether or not you claimed it.
Basis, allocation, and the schedule
Depreciable basis is your purchase price plus capitalized closing costs and improvements, minus the value allocated to land. Land does not wear out and cannot be depreciated. Allocation is commonly based on the county assessor's ratio between land and improvement value, though an appraisal supporting a different allocation is defensible.
Residential rental property uses a 27.5-year straight-line schedule; nonresidential real property uses 39 years. On a $400,000 building basis, that is roughly $14,545 of annual deduction on residential — often enough to shelter most or all of the property's cash flow from current tax.
Cost segregation and bonus depreciation
A cost segregation study engineers the purchase price into components: land improvements at 15 years, personal property like appliances, carpet, and certain fixtures at 5 or 7 years, and the remaining structure at 27.5 or 39. Shorter-life components become eligible for bonus depreciation.
The result is a large deduction concentrated in the first year or two. Studies typically cost several thousand dollars and are usually worth it above a certain property value. Bonus depreciation percentages have changed repeatedly through legislation — confirm the current-year percentage with your CPA before modeling a deal around it.
Passive activity limits — the catch
Rental activities are generally passive, and passive losses can only offset passive income for most taxpayers. Excess losses suspend and carry forward until you have passive income or dispose of the activity in a fully taxable transaction.
Two important exceptions. Taxpayers with modified AGI under $100,000 may deduct up to $25,000 of rental losses against ordinary income, phasing out completely at $150,000. And qualifying as a real estate professional — over 750 hours and more than half your personal service time in real property trades, with material participation — makes rental losses non-passive. That status is heavily scrutinized and requires contemporaneous time records.
Recapture at sale
When you sell, depreciation you took reduces basis and increases gain. Unrecaptured Section 1250 gain is taxed at up to 25%, above long-term capital gains rates. Depreciation claimed on shorter-life personal property is recaptured as ordinary income under Section 1245.
Critically, recapture applies to depreciation allowed or allowable — meaning you are taxed on depreciation you could have claimed even if you did not. There is no benefit to skipping it. A 1031 exchange defers both gain and recapture; see 1031 exchanges.
Frequently asked questions
When does depreciation start?
When the property is placed in service — available and ready for rent — not when you buy it. A property purchased in March and rented in June begins depreciating in June, using the mid-month convention.
Can I depreciate my primary residence?
No, but you can depreciate the portion used regularly and exclusively for business, or the rented portion of a house hack, allocated by square footage.
Is cost segregation an audit red flag?
Not inherently. A properly engineered study with documentation is a recognized method. A study performed without engineering support on a small property is a weaker position.
Sources & further reading
- IRS Publication 946, How to Depreciate Property
- IRS Publication 527, Residential Rental Property
- IRC §469 passive activity rules; §1245 and §1250 recapture
Figures and rules change. Verify current requirements with the issuing agency or a licensed professional before acting.