How to Calculate Rental Property Depreciation and Reduce Your Tax Bill

What Depreciation Actually Does to Your Tax Bill

Depreciation is a non-cash deduction. You spend no money in the year you claim it, but it reduces your taxable rental income dollar for dollar.

On a property with a $300,000 depreciable basis, the annual deduction is $10,909. If you sit in the 32% federal bracket, that single deduction eliminates $3,491 in federal tax owed. Over a 10-year hold, that is $34,910 in tax you never paid.

The deduction does not disappear. It converts. When you eventually sell, the IRS recaptures depreciation at a flat 25% rate under Section 1250. That rate is still lower than the 32% or 37% ordinary income rate you would pay on rental profits without the shelter.

The math almost always favors claiming depreciation aggressively.

The Three Numbers You Must Establish First

Before you calculate anything, you need three figures pinned down.

1. The Depreciable Basis

This is not the purchase price. It is the purchase price, plus closing costs you capitalize (legal fees, title insurance, recording fees), plus the cost of any improvements made before the property was placed in service, minus the value of the land.

Land does not depreciate. The IRS does not allow it. Buildings wear down. Land does not.

A property purchased for $425,000 with $8,200 in capitalized closing costs and a land value of $85,000 has a depreciable basis of $348,200.

2. The Date Placed in Service

Depreciation begins when the property is available for rent, not when a tenant moves in. If you completed renovations on August 15 and listed the property that day, depreciation starts August 15.

This date triggers the mid-month convention. The IRS treats every property as placed in service at the midpoint of the month it actually became available. August 15 becomes August 1 for calculation purposes, giving you 4.5 months of depreciation in year one.

3. The Recovery Period

Residential rental property: 27.5 years. Commercial rental property: 39 years.

If your property has residential units above a retail space, you must allocate the basis between the two components and apply separate recovery periods.

The Standard Depreciation Calculation

The formula for residential property after the first year is simple.

Annual Depreciation = Depreciable Basis / 27.5

Year one requires the mid-month convention. The IRS publishes Table A-6 in Publication 946 with exact percentages for each month placed in service. You do not need to memorize the table. You need to know it exists and that your software or tax professional should apply it.

Worked Example 1: Single-Family Rental in Year One

Purchase price: $385,000 Capitalized closing costs: $6,400 Land value (per county assessment): $77,000 Date placed in service: March 10, 2025

Depreciable basis: $385,000 + $6,400 - $77,000 = $314,400

Full-year depreciation: $314,400 / 27.5 = $11,432 per year

Year-one depreciation using the IRS mid-month table for March (month 3): the applicable percentage is 2.879%.

Year-one deduction: $314,400 x 2.879% = $9,050

From year two through year 27, the deduction is $11,432 annually. In year 28, you claim the remaining partial-year balance.

At a 32% federal rate, the year-one deduction saves $2,896 in federal taxes.

Worked Example 2: Multi-Unit Property with Improvement Allocation

Purchase price: $720,000 Capitalized closing costs: $11,500 Land value: $144,000 Roof replacement before first tenant (August, placed in service October): $28,000 Date placed in service: October 22, 2025

Depreciable basis: $720,000 + $11,500 - $144,000 + $28,000 = $615,500

Full-year depreciation: $615,500 / 27.5 = $22,382 per year

Year-one percentage for October (month 10): 0.321% per Publication 946 Table A-6.

Year-one deduction: $615,500 x 0.321% = $1,976

This is a critical point. Buying in October instead of January costs you roughly $19,900 in first-year depreciation. That is a $6,368 difference in taxes at the 32% bracket. Timing your closing matters.

Component Depreciation: The Strategy Most Owners Skip

The standard 27.5-year calculation applies to the building as a single asset. A cost segregation study separates the building into individual components, each with its own recovery period.

Personal property components (appliances, carpet, fixtures): 5-year recovery. Land improvements (parking lots, landscaping, fencing): 15-year recovery. Structural components: 27.5-year recovery.

Front-loading depreciation through cost segregation can produce $30,000 to $80,000 in additional first-year deductions on a $600,000 property. The deductions are not additional. They are accelerated. You claim more now and less later.

A cost segregation study costs between $4,000 and $15,000 depending on property size and complexity. On a large commercial or multi-unit property, that fee pays for itself in year one.

Bonus depreciation under current tax law (phasing down from 60% in 2024 toward 0% by 2027 unless extended) allows immediate expensing of qualifying 5-year and 15-year assets identified in a cost segregation study.

Passive Activity Rules and the $25,000 Allowance

Depreciation deductions from rental properties are passive losses. You cannot freely offset active income with passive losses. Two exceptions matter.

If your adjusted gross income is below $100,000 and you actively participate in managing the property, you can offset up to $25,000 of ordinary income with rental losses. This allowance phases out between $100,000 and $150,000 AGI at a rate of 50 cents per dollar.

Real estate professionals, as defined under IRC Section 469(c)(7), face no passive loss limitation. To qualify, you must spend more than 750 hours per year in real estate activities and more than half your working time in those activities. Meet both tests, and your depreciation deductions offset any income category.

Unused passive losses carry forward. They offset future passive income or convert to recognized losses in the year you sell the property.

What Happens to Depreciation When You Sell

The IRS recaptures all depreciation claimed at ordinary income rates up to 25%, under Section 1250 unrecaptured gain rules.

On the multi-unit property from Example 2, assume you hold for 15 years. You would have claimed roughly $334,730 in cumulative depreciation (one partial year plus 14 full years).

At sale, $334,730 of your gain is taxed at 25% rather than the long-term capital gains rate of 15% or 20%. The additional tax cost is approximately $33,473 to $66,946 depending on your rate differential.

This is still financially favorable if you invested the annual tax savings at even a 5% return over the holding period.

How to Report Rental Depreciation

You report depreciation on Schedule E, Supplemental Income and Loss. You carry the depreciation calculation detail on Form 4562, Depreciation and Amortization, in the first year and in any year you add a new asset.

Your tax software generates Form 4562 automatically when you enter the asset details. The critical inputs: asset description, date placed in service, cost basis, and property classification. A residential rental property is classified as 27.5-year MACRS property.

Keep records of your cost basis calculation indefinitely. The IRS can audit the gain calculation at sale regardless of when the depreciation was originally claimed.

Run Your Numbers Before Filing

The difference between a correct depreciation calculation and a careless one can exceed $5,000 in tax per year on a single property. Over a 20-year hold, that compounds into a meaningful wealth gap.

The CalcMoney income tax calculator lets you model your rental income, apply your depreciation deduction, and see the after-tax outcome before you commit to a position on your return. Enter your gross rents, your operating expenses, and your calculated depreciation figure. The tool shows your effective tax rate, your marginal rate impact, and your net rental income after federal tax.

Calculate your rental property tax position now →

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