What is Depreciation in Real Estate?

In real estate, depreciation refers to the IRS-permitted tax deduction that allows rental property owners to recover the cost of a building over its "useful life." This is a paper deduction — you do not actually spend this money — that reduces your taxable rental income each year. It is one of the most powerful tax benefits of owning investment real estate.

The 27.5-Year Residential Depreciation Schedule

The IRS requires residential rental properties to be depreciated over 27.5 years using the straight-line method. Your annual depreciation deduction equals the depreciable basis (purchase price plus acquisition costs, minus land value) divided by 27.5. If you buy a rental property for $350,000 and the land is valued at $50,000, your depreciable basis is $300,000 and your annual deduction is $10,909. Use the Rental Depreciation Calculator to compute this for any property.

What Can and Cannot Be Depreciated

Only the structure (building) and certain improvements can be depreciated — land cannot, because it does not wear out. Appliances, carpeting, and fixtures have shorter depreciation schedules (5–7 years) under cost segregation analysis, which can accelerate deductions significantly in the early years of ownership. The land value is typically determined by the property tax assessment's land-to-improvement ratio, or by an appraisal.

Tax Depreciation vs Economic Depreciation

Tax depreciation is a bookkeeping entry that reduces taxable income. Economic depreciation refers to actual physical decline in a property's condition. In appreciating markets, properties often increase in market value while simultaneously generating tax depreciation deductions — a "phantom loss" that shelters real rental income. This disconnect between book value and market value is at the heart of real estate's tax efficiency.

Depreciation Recapture at Sale

When you sell, the IRS "recaptures" accumulated depreciation by taxing it at a maximum rate of 25% (Section 1250 recapture), regardless of your ordinary income tax bracket. If you claimed $50,000 in depreciation over 5 years, expect to owe up to $12,500 in recapture tax at sale. This is why many long-term investors use a capital gains analysis or a 1031 exchange to defer this tax indefinitely.