How do I know how much of the purchase price is land vs. building?

The most common approach is the ratio from your county property tax assessment, which typically breaks out land and improvement value separately. A formal appraisal that allocates value is stronger support if the IRS ever asks, especially for an unusual property. You can't depreciate land, so getting this allocation right (and not artificially low) matters — many owners default to 20-25% land value absent a specific reason to use something else.

What happens to depreciation when I sell?

You pay depreciation recapture — the accumulated depreciation is taxed at a maximum 25% federal rate (unrecaptured §1250 gain), on top of ordinary capital gains tax on any appreciation. This applies whether or not you actually claimed the deduction each year, which is why skipping it doesn't avoid the recapture bill — it just means you paid for it without getting the benefit. See the depreciation recapture article for the full mechanics.

Can I use depreciation to offset my W-2 income?

Usually not directly. Rental losses are passive by default, and passive losses can only offset passive income — not wages — unless you qualify for the $25,000 special allowance (phased out at higher income) or meet the real estate professional test. See the Passive Activity Loss Rules article for how that actually works before assuming a rental loss will lower your day-job tax bill.

What is cost segregation, and is it worth it?

A cost segregation study breaks a property into components — appliances, carpeting, certain electrical and plumbing — that qualify for much shorter depreciation lives (5, 7, or 15 years) instead of the full 27.5. Combined with bonus depreciation, this can front-load a large deduction into year one instead of spreading it evenly. It typically costs a few thousand dollars to have done professionally and makes the most sense on larger properties or when you specifically need a big deduction in a high-income year — for a single modest rental, the standard 27.5-year schedule is usually simpler and close enough.

Do I have to depreciate my rental if I'd rather not deal with it?

You can choose not to claim it, but the IRS calculates recapture on sale based on depreciation "allowed or allowable" — meaning the amount you were entitled to claim, whether or not you did. Skipping it gives up a real deduction now for no reduction in the tax bill later. There's essentially no scenario where declining to depreciate helps you.

Real estate & rental

Rental Property Depreciation Explained: The Deduction That Doesn't Feel Like One

You don't write a check for depreciation, but it's often the single biggest deduction on a rental — sometimes enough to turn a cash-flow-positive property into a tax loss. Here's how the 27.5-year rule actually works.

6 min read · Published August 2026

Key Takeaways

Residential rental buildings depreciate straight-line over 27.5 years — only the building, never the land underneath it.
Depreciation is a non-cash deduction: it lowers your taxable rental income without costing you a dollar in the year you claim it.
It's common for a rental to have positive cash flow and a taxable loss in the same year, once depreciation and mortgage interest are subtracted from net operating income.
The IRS treats depreciation as 'allowed or allowable' — you owe recapture tax on it when you sell whether or not you actually claimed it, so there's no upside to skipping it.
Cost segregation can accelerate some of that deduction into the first few years instead of spreading it evenly over 27.5 — worth a look on larger properties.

A deduction you never write a check for

Most deductions track spending — you paid for insurance, so you deduct insurance. Depreciation is different. It’s the IRS’s way of spreading the cost of a wearing-out asset (the building) over its useful life, and it reduces your taxable income every year without any matching cash expense. That’s exactly why it’s easy to underestimate — the biggest line item on a rental’s tax return often isn’t something you paid for this year at all.

Depreciation is the deduction that shows up on your tax return but never on your bank statement.

The 27.5-year rule

Residential rental property depreciates straight-line over 27.5 years — meaning you deduct roughly 1/27.5 (about 3.6%) of the depreciable basis every year, evenly, for the life of the schedule. Commercial property uses 39 years instead. Two things are excluded from the depreciable basis entirely:

Land — land doesn’t wear out, so the IRS doesn’t let you depreciate it, no matter how much of the purchase price it represents.
Anything not yet placed in service — depreciation starts when the property is ready and available to rent, not on the closing date if renovations come first.

A $300,000 rental with 20% land value

Purchase price$300,000

Land value (20%, non-depreciable)$60,000

Depreciable building value$240,000

Depreciation period27.5 years

Annual depreciation deduction≈ $8,727

That's nearly $9,000 a year in deductions the owner never wrote a check for — enough, combined with mortgage interest, to turn a property with genuinely positive cash flow into a paper loss on the tax return.

Why cash flow and taxable income diverge

Net operating income (rent minus operating expenses) isn’t what you’re taxed on. The IRS also lets you subtract mortgage interest and depreciation before arriving at taxable rental income — and neither of those show up as cash leaving your pocket beyond the interest portion of your mortgage payment (principal isn’t deductible at all). The result: a rental that’s genuinely profitable in cash terms can still report a loss.

This is normal, not a red flag

A rental showing a tax loss while generating positive cash flow isn’t evidence of a bad investment or an error — it’s the ordinary result of depreciation being a non-cash deduction. Real estate investors describe this as one of the asset class’s core tax advantages, not a loophole.

The catch: it doesn’t disappear, it defers

Depreciation lowers your tax bill now, but the IRS collects on it later. When you sell, the accumulated depreciation is recaptured — taxed at up to 25% federally (separate from, and on top of, regular capital gains tax on appreciation). This is why depreciation is better described as a deferral than a permanent deduction: it’s valuable because a dollar of tax saved today is worth more than a dollar of tax paid years from now, not because the income avoids tax forever.

Two common ways owners deal with the eventual recapture bill: hold the property until death (heirs get a stepped-up basis, wiping out the deferred gain and depreciation recapture), or use a 1031 exchange to roll the gain into another property and keep deferring. Both are worth planning around well before a sale, not after.

Accelerating it: cost segregation

The 27.5-year schedule assumes the entire building depreciates at one uniform rate. In reality, carpeting, appliances, and certain electrical and plumbing components wear out faster and qualify for much shorter depreciation lives — 5, 7, or 15 years. A cost segregation study identifies and reclassifies those components, and combined with bonus depreciation, can front-load a large share of the total deduction into the first year or two instead of spreading it evenly over nearly three decades.

This matters most when you specifically want a large deduction in a high-income year, or on larger multi-unit properties where the dollar amounts justify the study’s cost. For a single modest rental, the standard schedule is usually close enough that the added complexity isn’t worth it.

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Sources & References

Frequently asked

Questions owners actually ask

How do I know how much of the purchase price is land vs. building?: The most common approach is the ratio from your county property tax assessment, which typically breaks out land and improvement value separately. A formal appraisal that allocates value is stronger support if the IRS ever asks, especially for an unusual property. You can't depreciate land, so getting this allocation right (and not artificially low) matters — many owners default to 20-25% land value absent a specific reason to use something else.
What happens to depreciation when I sell?: You pay depreciation recapture — the accumulated depreciation is taxed at a maximum 25% federal rate (unrecaptured §1250 gain), on top of ordinary capital gains tax on any appreciation. This applies whether or not you actually claimed the deduction each year, which is why skipping it doesn't avoid the recapture bill — it just means you paid for it without getting the benefit. See the depreciation recapture article for the full mechanics.
Can I use depreciation to offset my W-2 income?: Usually not directly. Rental losses are passive by default, and passive losses can only offset passive income — not wages — unless you qualify for the $25,000 special allowance (phased out at higher income) or meet the real estate professional test. See the Passive Activity Loss Rules article for how that actually works before assuming a rental loss will lower your day-job tax bill.
What is cost segregation, and is it worth it?: A cost segregation study breaks a property into components — appliances, carpeting, certain electrical and plumbing — that qualify for much shorter depreciation lives (5, 7, or 15 years) instead of the full 27.5. Combined with bonus depreciation, this can front-load a large deduction into year one instead of spreading it evenly. It typically costs a few thousand dollars to have done professionally and makes the most sense on larger properties or when you specifically need a big deduction in a high-income year — for a single modest rental, the standard 27.5-year schedule is usually simpler and close enough.
Do I have to depreciate my rental if I'd rather not deal with it?: You can choose not to claim it, but the IRS calculates recapture on sale based on depreciation "allowed or allowable" — meaning the amount you were entitled to claim, whether or not you did. Skipping it gives up a real deduction now for no reduction in the tax bill later. There's essentially no scenario where declining to depreciate helps you.

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Educational content only. This article is for informational purposes and does not constitute tax, legal, or financial advice. Every situation is different — consult a qualified professional before acting on anything here.