How Depreciation Works on a Rental

How does depreciation work on a rental property? You recover the building’s cost over time by deducting a portion of that cost each year. Publication 527 requires the straight-line method and a mid-month convention for residential rental property. Under the general depreciation system, the recovery period for the building and its structural components is 27.5 years. Land stays in a separate account. Publication 527 says you cannot depreciate the cost of land, because land generally does not wear out, become obsolete, or get used up.

These figures are an illustration of the method. They are not a tax opinion or a promise of tax savings. An inquiry is not an approval.

How Does Depreciation Work on a Rental Property Under Straight Line

Publication 527 names three factors: your basis in the property, the recovery period, and the depreciation method. For a residential rental building placed in service under the current MACRS rules, the method on this page is straight line, the recovery period is 27.5 years, and the convention is mid-month. Straight line means the same deduction in a full year of the recovery period. Mid-month means property placed in service, or disposed of, during any month is treated as placed in service, or disposed of, at the midpoint of that month. The first year and the year of sale are partial. Publication 527’s percentage tables turn the month into the percentage you use.

You can depreciate property when you own it, you use it in the rental activity, it has a determinable useful life, and it is expected to last more than one year. You are the owner for this purpose even if the property is subject to a debt. You begin when you place it in service. You stop when you have fully recovered the basis, or when you retire the property, whichever happens first.

Placed in service means ready and available for rent. Publication 527’s pattern is practical. You buy a house, finish the work required to rent it, and advertise. Depreciation can begin when the house is ready and available, even if the first tenant moves in later. A temporary vacancy does not stop the deduction. If the unit is empty while you turn it over, you continue to depreciate it. You retire it when you sell it, convert it to personal use, abandon it, or it is destroyed.

Split the Cost Between Land and Building

If you buy a building and the price includes the land, Publication 527 says you must divide the cost. The share for each asset is the ratio of that asset’s fair market value to the fair market value of the whole property at the purchase. If you are not certain of those values, you can divide the cost using assessed values for real estate tax purposes.

Use that assessed-value method on a purchase whose cost basis is $350,000, a figure that already includes the closing costs Publication 527 allows in basis. The latest assessment is $280,000, of which $220,000 is the building and $60,000 is the land. The building’s share is $220,000 divided by $280,000. Applied to the $350,000 cost, that ratio is a $275,000 building account and a $75,000 land account.

A full year of straight-line depreciation on the building is $275,000 divided by 27.5, or $10,000. The year you place the house in service is smaller than $10,000, because of the mid-month convention. The year you sell is smaller too. Use the row in Publication 527 for the month the property was placed in service, and keep using that row. The $75,000 land account produces no annual deduction. Clearing, grading, and landscaping are usually part of the land. Publication 527 allows depreciation of plantings only when they are so closely tied to the building that they will be destroyed if the building is replaced. The ordinary lot preparation stays with the land.

How the $350,000 was assembled from price and closing costs is the subject of rental property cost basis. This page starts after that total exists and splits it.

What Uses 27.5 Years, and What Does Not

Publication 527’s recovery table puts residential rental buildings and structural components in the 27.5-year general-depreciation-system class. The table names furnaces, water pipes, and venting as examples of those structural components. An addition or improvement takes the recovery period that would apply to the building if the building had been placed in service at the same time as the improvement. A new roof or a new furnace, once it is a capital improvement, is recovered on that residential rental life. It is its own asset. The recovery starts when the improvement is placed in service.

A $14,000 furnace that belongs in that class has a full-year straight-line deduction of $14,000 divided by 27.5, about $509. The first year is partial under the mid-month convention, the same way the building’s first year is partial. Whether the invoice is a repair you deduct now or an improvement you capitalize is decided before any of this math. That test is on the repair versus improvement page.

The same table puts appliances, carpet, and furniture in shorter classes. A refrigerator does not use the 27.5-year life. This page stays with the building and its structural components. Personal property in the unit follows the class the table assigns it.

You deduct depreciation only on the part of the property used for rental. If you also use the dwelling yourself, Publication 527 limits the deduction to the rental portion. A house you lived in and later converted to a rental has a further rule: the basis for depreciation is the lesser of adjusted basis or fair market value on the date of the change. Converting a primary residence to a rental walks through that starting point. Depreciation on this page assumes the property is already a rental you hold to rent.

The Deduction, the Cash, and a Later Sale

The $10,000 full-year deduction does not write a check. It reduces taxable rental income if the passive-activity rules let you use it. Those limits are explained in passive activity loss rules for a rental. A property can show cash left after the mortgage and still show a tax loss once depreciation is included. It can also show the reverse if principal paydown is large and depreciation is the only non-cash line. Track the bank account and the return as two statements.

Publication 527 says you must reduce basis by depreciation you were allowed to claim, even if you did not claim it. Skipping a year on the return does not preserve basis for a later sale. When you sell, adjusted basis is lower by the depreciation allowed or allowable, and the gain is larger by that amount. The federal gain computation is on the capital gains tax on rental property page. The separate maximum rate on unrecaptured section 1250 gain is a different article. This page stops at the annual straight-line deduction and the basis reduction it causes.

You stop depreciating when the deductions equal the depreciable basis, or when you retire the property. A sale retires it. You still claim the partial-year deduction for the months it was in service during the year of sale, using the mid-month convention. You do not keep deducting the building after the transfer.

Publication 527 also describes an alternative depreciation system election, made in the first year and irrevocable for that property. The recovery period under that election is different. Most owners reading this page are looking at the general system: straight line, 27.5 years, mid-month, land excluded. If someone proposes a different life for the building, ask which system and which publication table they are using. The answer should be visible on Form 4562 and on a schedule that shows the $275,000 building, the $75,000 land, and each improvement in its own row.

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Frequently Asked Questions

Can I depreciate the full purchase price of a rental?

Only the part of the cost assigned to the building and other depreciable assets. Publication 527 requires you to separate land. Using the whole price as depreciable basis treats the land as if it wears out. In the illustration, $75,000 of a $350,000 cost basis produces no depreciation deduction.

Why is the first-year deduction smaller than the full-year amount?

Residential rental property uses a mid-month convention. Publication 527 treats the property as placed in service at the midpoint of the month you put it in service, and the percentage tables reflect that. A full year of $10,000 on a $275,000 building is the steady deduction after the partial first year, until the year you dispose of the property, which is partial again.

Do I keep depreciating a rental while it is vacant?

Yes, while the vacancy is temporary and the property remains in the rental activity. Publication 527 says you continue the deduction when the property is idle, including while you make repairs between tenants. You stop when you retire it from rental use, including when you sell it or convert it to personal use.

Does the mortgage balance change depreciation?

The loan balance does not. You depreciate basis, and Publication 527 treats you as the owner even when the property secures a debt. Principal payments are not a depreciation method. Publication 527 says you cannot simply deduct mortgage or principal payments as a substitute for depreciation.

Where do capital improvements go?

Each improvement is its own asset. Publication 527 depreciates an improvement to residential rental property over the recovery period that would apply to the building if the building were placed in service with the improvement. A structural improvement uses 27.5-year straight line under the general system. The cost has to be a capitalized improvement first. Repairs you are allowed to deduct stay off the depreciation schedule.