When you’re investing in real estate, most of your focus is probably on cash flow, appreciation, and ROI. But there’s a less talked-about financial benefit that can have a major impact on your bottom line—depreciation.
Used correctly, depreciation can reduce your taxable income, improve your returns, and even help you build long-term wealth. Here’s how it works, and why every real estate investor should understand it.
What Is Depreciation in Real Estate?
Depreciation is a tax deduction that allows you to recover the cost of income-producing property over time—essentially recognizing that buildings (not land) wear out and lose value over the years.
The IRS lets you deduct a portion of your property’s cost each year, even if the property is actually increasing in market value. That’s right—your property can go up in value, but you still get to write it down for tax purposes.
How Residential Real Estate Depreciation Works
- Applies to: Residential rental properties
- Recovery period: 27.5 years (as set by the IRS)
- Method used: Straight-line depreciation
Example:
You purchase a rental property for $300,000, and land is valued at $50,000 (land can’t be depreciated). That means you can depreciate:
$250,000 ÷ 27.5 years = $9,090.91 per year
That’s over $9,000 you can deduct from your rental income each year—potentially turning a taxable gain into a paper loss.
Why Depreciation Is So Powerful for Investors
- Tax Shelter for Cash Flow: You might be cash flow positive but still report a loss on paper thanks to depreciation. That can reduce or eliminate the income tax you owe on your rental income.
- Increased ROI: Lower taxes = more profit in your pocket = better returns on your investment.
- Defers Tax Liability: You’ll owe recapture tax when you sell, but that can be deferred with strategies like a 1031 exchange.
What About Commercial Property?
Commercial buildings depreciate over 39 years instead of 27.5. The same principles apply—just over a longer timeline.
Bonus: Cost Segregation
Want to accelerate depreciation and front-load more deductions in the early years?
A cost segregation study breaks your property down into individual components (like appliances, flooring, landscaping) that can be depreciated over 5, 7, or 15 years instead of 27.5. This strategy can supercharge your tax savings—especially useful if you’re trying to offset high income in the early years of ownership.
Key Rules and Tips
- You must be renting the property (personal residences don’t qualify).
- Start depreciating the property as soon as it’s available for rent, not when it’s actually rented.
- Keep good records of your property basis, improvements, and allocation between land/building.
- You can’t skip depreciation—if you don’t take it, the IRS still assumes you did and may recapture it when you sell.
Depreciation Recapture (Don’t Panic!)
When you sell a property, any depreciation you’ve claimed gets “recaptured” at a 25% tax rate. Yes, it reduces your tax benefit on the back end—but with good planning (1031 exchange, reinvestment, timing), you can defer or manage that liability.
Bottom Line
Depreciation isn’t just an accounting concept—it’s one of the biggest tax advantages in real estate investing. If you’re not leveraging it, you could be leaving thousands (or more) on the table.
Work with an accounting professional who understands real estate, consider a cost segregation study, and make depreciation part of your investment strategy—not just your tax prep.
