How Rental Depreciation Works
When you buy a rental property, the IRS considers the building a wasting asset that wears out over time. Residential property is depreciated over 27.5 years, commercial property over 39 years. You must separate the purchase price into land (not depreciable) and building (depreciable). A common split is 80% building / 20% land, though you should use the county tax assessment ratio or an appraisal for accuracy.Calculating Your Depreciation
Take your cost basis (purchase price + closing costs + improvements) and subtract land value. Divide by 27.5. Example: You buy a rental for $250,000. Land is valued at $50,000. Depreciable basis: $200,000. Annual depreciation: $200,000 / 27.5 = $7,273. This deduction is taken on Schedule E every year for 27.5 years. Capital improvements (new roof, HVAC, renovation) are added to your basis and depreciated separately.Example: BRRRR Investor
You buy a distressed property for $80,000, spend $40,000 on rehab, and it appraises at $160,000. Your cost basis: $80,000 + $40,000 = $120,000. Land value (20%): $24,000. Depreciable basis: $96,000. Annual depreciation: $96,000 / 27.5 = $3,491. If rent is $1,200/month ($14,400/year) and expenses are $8,000, your cash profit is $6,400 — but after depreciation, your taxable income is only $2,909.
Depreciation Recapture
When you sell a rental property, the IRS taxes all depreciation you claimed (or should have claimed) at 25% — this is depreciation recapture. If you claimed $50,000 in total depreciation over the years, you owe $12,500 in recapture tax at sale, in addition to any capital gains tax. This is why many investors use 1031 exchanges to defer both capital gains and depreciation recapture by rolling proceeds into a new property.
When you sell a rental property, the IRS taxes all depreciation you claimed (or should have claimed) at 25% — this is depreciation recapture. If you claimed $50,000 in total depreciation over the years, you owe $12,500 in recapture tax at sale, in addition to any capital gains tax. This is why many investors use 1031 exchanges to defer both capital gains and depreciation recapture by rolling proceeds into a new property.
Cost Segregation Studies
A cost segregation study breaks your property into components with shorter depreciation lives: 5-year property (appliances, carpeting, fixtures), 7-year property (office furniture, certain equipment), 15-year property (landscaping, parking lots, fences), and 27.5/39-year property (the building structure). Combined with bonus depreciation, this can accelerate hundreds of thousands in deductions to year one. Cost seg studies typically cost $3,000-10,000 but can generate 10x+ in tax savings.Track Property Depreciation
Hivebooks tracks depreciation schedules for each rental property, including cost segregation components, so your Schedule E is always accurate.
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