The deduction that does not cost you anything
Every other line on a rental's tax return represents money that left your bank account. The mortgage interest left. The insurance left. The plumber definitely left. Depreciation is the one deduction that does not work that way. It is the IRS letting you write off the cost of the building a slice at a time, on the theory that the structure is wearing out even in years when the market value climbs.
For residential rental property that write-off runs over 27.5 years, straight line, which just means the same amount every full year. Non-residential property runs over 39 years on the same method. It is the largest deduction most small landlords have and, in my experience, the least understood. It also has a sting in the tail, because every dollar you deduct gets settled up when you sell.
The mechanics are simpler than the reputation. Only three inputs matter: what you paid, how much of that was land, and what month the property was placed in service.
Why land is excluded, and how to split it out
Land does not wear out. A parking lot from 1974 is the same dirt it always was, so the IRS will not let you depreciate it. Your first real job is splitting the purchase price between land and building, and nobody hands you that number at closing.
The most common defensible method is the county assessor's ratio. Pull the assessment, note the land value and the improvement value, and use the proportion rather than the dollar amounts. Say the assessor shows $40,000 of land and $160,000 of improvements, a total of $200,000. Land is 20% of assessed value. Apply that 20% to what you actually paid, $350,000 in our example, and you get $70,000 of land and a depreciable basis of $280,000.
Three details trip people up on the way to that number.
- Capitalized closing costs such as title fees and transfer taxes get added to basis, then split by the same land ratio. Prepaid insurance and loan points do not.
- An appraisal that separates site value is also acceptable and usually produces a different percentage. Pick one method, document why, stay consistent.
- Later improvements start their own clock. A new roof in year six is not folded into the original schedule, it depreciates alongside it. Appliances and carpet have shorter recovery periods still.
The mid-month convention, in plain English
Here is the rule that makes year one look wrong at first glance. Whatever month you place a residential rental in service, the IRS pretends it happened on the 15th. Buy in January and you get 11.5 months of deduction. Buy in June and you get 6.5. Place it in service on December 2 and you get half of December, which is almost nothing.
Publication 946 publishes these as year-one percentages of depreciable basis in Table A-6. Rounded to three decimals, they run like this.
- January 3.485, February 3.182, March 2.879
- April 2.576, May 2.273, June 1.970
- July 1.667, August 1.364, September 1.061
- October 0.758, November 0.455, December 0.152
The $350,000 example, start to finish
Take the property from earlier. Price $350,000, land 20% at $70,000, depreciable basis $280,000. Divide $280,000 by 27.5 and the full-year deduction is $10,181.82. That is the number you claim every complete year you own it, unchanged by rent increases, refinancing, or what the neighbors sold for.
Place it in service in January and year one gives you 11.5 months of that, which is $9,757.58, stated in Table A-6 as 3.485% of basis. Place it in service in June instead and year one gives you 6.5 months, which is $5,515.15, or the table's 1.970%. Same house, same price, same basis, and a $4,242 difference in first-year deduction decided entirely by when the listing went live.
Run your own version in the rental depreciation calculator, which uses the same table and the same convention. The reason to do it before you buy rather than the following April is that the month is sometimes negotiable and the tax year never is.
What the deduction is actually worth
Depreciation reduces taxable rental income, not cash flow. Suppose our house produces $9,400 of taxable profit after operating expenses and mortgage interest. The $10,181.82 deduction wipes that out and leaves a small paper loss, while the cash in your account is exactly what it was. That gap between paper result and bank result is why people call real estate tax-advantaged.
What happens to a paper loss depends on rules outside this arithmetic. Rental activity is generally passive, and passive losses offset passive income. Publication 527 covers the special allowance for active participants, the income levels at which it phases out, and the fact that losses you cannot use are suspended and carried forward.
Notice what depreciation does not touch. Cap rate and cash on cash are pre-tax, so the figures you compute in the cap rate calculator or the full rental property calculator are unaffected. Two investors can own identical buildings with identical cap rates and keep very different amounts of money, which is the difference I pulled apart in cap rate vs cash on cash.
It is not optional, and that is the trap
On my first rental I skipped depreciation for two years on purpose. My reasoning felt clever at the time. If I never claim it, I thought, there is nothing to hand back when I sell. I was pleased with myself for about twenty-four months.
That is not how the statute works. At sale your basis is reduced by the depreciation allowed or allowable, and allowable means the amount you were entitled to take whether or not you took it. Skipping it does not shrink the bill later. It just donates the deduction. I recovered mine through a Form 3115 accounting method change, which is a routine fix, but it cost me a preparer's time and was entirely self-inflicted.
The amount that comes back at sale is unrecaptured Section 1250 gain, taxed at up to 25%. I walked through the full sting, including how it stacks with capital gains and the net investment income tax, in depreciation recapture when you sell.
How I use the number now
My routine takes about ten minutes. Compute the land percentage from the assessment, apply it to the price plus capitalized closing costs, note the month the unit will genuinely be available for rent, then keep the resulting schedule in the property folder next to the closing documents.
That schedule earns its keep years later. Whenever you sell, or run a 1031 exchange calculator to see whether deferring makes sense, the single most important input is total depreciation claimed to date. Reconstructing it from a decade of returns is miserable. Writing it down as you go takes seconds.
One honest caveat to close on. This is arithmetic on published IRS tables, not tax advice, and your situation may involve entity structures, cost segregation, or loss carryforwards that change the answer. Confirm with a CPA before you file.
Questions people ask
No. Land does not wear out, so it is excluded from your depreciable basis. Split the price between land and improvements, usually with the county assessor's ratio, and depreciate only the improvement portion over 27.5 years.
The date the property was ready and available for rent, not the date you closed or the date a tenant moved in. A house you closed on in March but renovated until July is placed in service in July, giving a year-one figure of 1.667% of basis.
No, and it is the most expensive misunderstanding in rental taxes. At sale your basis is reduced by depreciation allowed or allowable, meaning the amount you were entitled to claim whether or not you claimed it. Skipping it forfeits the deduction without reducing the bill.
With land at 20%, the depreciable basis is $280,000 and the full-year deduction is $10,181.82. Year one is prorated by month: January gives $9,757.58 for 11.5 months, June gives $5,515.15 for 6.5 months.
No. Appliances and carpet have shorter recovery periods on their own schedules. Capital improvements to the building do use 27.5 years but start from their own placed-in-service date, running alongside the original schedule rather than merging into it.
