Depreciation lets you deduct the cost of the building (not the land) over 27.5 years as a non-cash expense. On a $300K rental where the land is worth $60K, you can deduct $8,727/year in depreciation ($240K / 27.5). This reduces your taxable income even though you're not actually spending that money. It's one of the biggest tax advantages of rental property ownership.
How to Calculate Depreciation (Building Value / 27.5 Years)
To calculate depreciation, take the purchase price of the property and subtract the land value (land doesn't depreciate). Divide the remaining building value by 27.5. For a $300K property with $60K land value: ($300K - $60K) / 27.5 = $8,727/year. This deduction applies every year you own the rental.
Land vs Building (Only Building Depreciates)
Only the building structure and improvements depreciate, not the land. The land value is typically 20-30% of the total property value, depending on location. Your property tax assessment often shows the land vs building breakdown, which is a good starting point for determining the split.
What It Means for Your Taxes (Reduces Taxable Income)
Depreciation is a non-cash expense that reduces your taxable rental income. If your rental generates $10,000 in cash flow but you claim $8,727 in depreciation, you only pay taxes on $1,273. Many investors show a paper loss on their tax returns even while collecting positive cash flow.
Depreciation Recapture (Pay Back When You Sell, Unless 1031 Exchange)
When you sell a rental property, the IRS recaptures the depreciation you claimed. Depreciation recapture is taxed at a maximum rate of 25%, while the rest of the capital gain is taxed at the lower long-term capital gains rate. A 1031 exchange defers both the capital gains and depreciation recapture.
How to Maximize Depreciation (Cost Segregation Study)
A cost segregation study breaks down the property into components with shorter depreciation lives (5, 7, or 15 years) instead of 27.5 years. This accelerates your depreciation deductions in the early years of ownership. Components like flooring, appliances, landscaping, and certain improvements can be depreciated much faster.