Depreciation is the rental property owner's most valuable tax deduction — a paper loss on a real, cash-flowing asset. Yet most new landlords calculate it wrong by depreciating the purchase price instead of the building value. Here is the correct, step-by-step method.
The Core Rule
Residential rental property (1-4 unit buildings included) is depreciated straight-line over 27.5 years using the mid-month convention — the IRS treats every property as placed in service at the midpoint of whatever month you acquired it, so your first year is always a partial year.
Step 1: Establish Your Depreciable Basis
Depreciable basis = purchase price + closing costs attributable to the purchase − land value.
What's included: title fees, legal fees, recording fees, survey costs, transfer taxes. What's excluded: loan costs (origination, points) — those amortize separately over the loan term.
Land is never depreciated. You must allocate purchase price between land and building, using:
- The county assessor's assessed value split (most common)
- A professional appraisal allocating value
- Reasonable market estimates of land value
Step 2: Apply the Mid-Month Convention
Year 1 depreciation = annual amount × (months remaining in year including placement month − 0.5) ÷ 12.
The IRS publishes table percentages; for a property placed in service in, say, June, first-year depreciation is 3.636% of basis instead of the full 3.636% annual rate (1 ÷ 27.5 = 3.6364%).
Worked Example: $380,000 Duplex
- Purchase price: $380,000
- Purchase closing costs (title, legal, recording): $4,200
- Assessor split: land 25% / building 75%
- Placed in service (ready to rent): May 15
Calculation:
- Basis: $380,000 + $4,200 = $384,200
- Building basis: $384,200 × 0.75 = $288,150
- Annual depreciation: $288,150 ÷ 27.5 = $10,478/year
- First year (May, mid-month): 6.5/12 × $10,478 = $5,676
- Full years 2-27: $10,478/year
- Final year 28: the remaining 5.5 months
Over the full schedule, you deduct the entire $288,150 building basis — while the property may have appreciated the whole time.
What Else Can Be Depreciated (Separately)
- Capital improvements: a $14,000 roof is depreciated over 27.5 years from installation (see our CapEx vs. repairs guide)
- Appliances, carpet, furniture in rentals: 5-year property
- Land improvements (fences, parking lot): 15-year property
- Loan points: amortized over the loan term
The Cash Flow Magic
Suppose your duplex produces $6,000/year of true cash flow after all expenses. With $10,478 of depreciation, your taxable rental income is negative $4,478 — you keep the cash and report a loss. That loss can offset other passive income, and up to $25,000 of rental loss can offset ordinary income if you actively participate and earn under $100,000 MAGI (phasing out to $150,000).
Depreciation Recapture: The Other Side
When you sell, the IRS "recaptures" depreciation at a maximum 25% federal rate (plus state tax), regardless of your ordinary bracket. Two points:
- Recapture applies to depreciation taken or allowable — skipping depreciation does not avoid recapture; it just wastes the deduction.
- A 1031 exchange defers both gain and recapture (see our 1031 guide).
Common Mistakes
- Depreciating the full purchase price including land
- Forgetting to add purchase closing costs to basis
- Starting depreciation at closing instead of when the property is ready and available for rent
- Never taking depreciation (recapture happens anyway)
- Depreciating loan costs with the building instead of amortizing them
Track It Properly
Use tax software or a CPA, and keep a fixed-asset schedule listing every depreciable item, its basis, and its start date. The expense-tracking features of platforms like Stessa (see our software comparison) automate most of this.
This article is educational, not tax advice — confirm your specific situation with a CPA.