Depreciation deductions allow property owners to recover the cost of their property over time. For owners of residential rental property, the cost is typically recovered after 27.5 years. Depreciation deductions for rental property are allowed until all costs have been recovered or the owner no longer rents the property (e.g., it’s sold, destroyed, or taken off the rental market).
TABLE OF CONTENTS
If you own a house, apartment building, or other residential property that you rent to other people, you must report the rent payments as income on your taxes. But you can deduct (i.e., subtract) related expenses from your rental income, such as property management fees, cleaning and maintenance costs, insurance premiums, utilities, and the like. This reduces your overall tax bill.
There’s also another tax deduction available for landlords and investors – the deduction for depreciation on rental property. However, while day-to-day rental expenses are deducted in the year you spend the money, depreciation deductions are taken over several years.
Rental property depreciation is the process by which you deduct the cost of buying and/or improving real property that you rent. Depreciation spreads those costs across the property’s useful life.
For example, suppose you buy a building to use as a rental. Rather than taking a single, large tax deduction in the year you buy the property, you deduct a portion of the building’s cost as depreciation each year until you recover the entire cost.
The word "depreciation" is often used to describe a piece of property’s decline in value because of wear and tear. But depreciation deductions are really about recovering the cost of property, not assessing its value. As a result, you can deduct depreciation on rental property even if the property remains in tip-top shape.
You can depreciate residential rental property, such as a house or apartment building, if certain requirements are met. Residential rental property is defined as a building or other structure where at least 80% of its gross rental income for the year is from “dwelling units” (i.e., a place where people live). It doesn’t include a hotel, motel, or other place where more than half of the rooms are used as temporary living spaces.
According to the IRS, you can only claim a depreciation deduction for residential rental property if:
However, even if you check all these boxes, you still can’t depreciate property that you start and stop renting in the same year. For example, if you buy rental property in January, you can’t claim a depreciation deduction if you sell it or take it off the rental market before the end of the year.
You can still be considered the owner of residential rental property if you have a mortgage on the property or it’s otherwise subject to a debt. But you generally can’t depreciate property if you’re actually renting it yourself and subletting it out to someone else.
To have a useful life, the property must wear out, decay, get used up, become obsolete, or lose its value from natural causes. Property that’s used up or worn out within one year is generally deductible as a regular rental expense in the year you pay for it.
Since land doesn’t wear out, become obsolete, or get used up, it doesn’t have a useful life. As a result, you generally can’t depreciate land. So, for instance, if you have a house that you rent on an acre of land, you can only claim a depreciation deduction for the house itself.
The costs of clearing, grading, planting, and landscaping are also generally treated as costs of land and can’t be depreciated. However, you might be able to depreciate certain land preparation costs if they’re closely associated with depreciable property. For example, if you plant trees so close to a house that you would have to remove them if you replaced the house, a depreciation deduction for the planting costs might be available using the house’s useful life.
You don't just get to depreciate the cost of buying residential rental property. Money spent to improve the property can be depreciated as well.
An improvement is anything that enhances the value or usefulness of a property, restores it to new or like-new condition, or adapts it to a new or different use. The list of potential improvements is endless, but common improvements include:
Routine repairs and maintenance aren’t considered depreciable improvements, so you can deduct repair and maintenance costs in the year you pay for them. For example, the cost of replacing a few boards on a deck is considered a maintenance expense that’s deductible right away. On the other hand, the cost of building a brand new deck is a depreciable improvement.
You can’t automatically start taking depreciation deductions for residential rental property or improvements when you pay for them. Instead, you must wait until the property or improvement is ready and available to generate rental income (even if you aren’t actually renting or otherwise using the property at that time). The IRS refers to this as putting the property "in service."
For example, you purchased wall-to-wall carpet for your rental property. It was delivered on January 20, but it wasn’t installed until February 1. In this case, the carpet isn’t placed in service until February 1. However, if the carpet had been installed when it was delivered on January 20, it would have been considered placed in service on that day even if the rental property wasn’t actually occupied until February or later.
If you convert your own home to rental property, you can begin depreciating it when it’s ready and available for use as rental property. The fact that it was previously used as non-depreciable property doesn’t matter as long as it satisfies all the requirements for depreciable rental property after the conversion.
If your rental property is temporarily unoccupied, you can continue to claim a depreciation deduction for the property. For example, if you have to make repairs to your rental property after a tenant moves out, you can still depreciate the property while it isn’t available for rent.
Depreciation of rental property generally continues until one of two things happens:
In most cases, your “cost basis” is what it costs you to acquire the rental property, including certain taxes and fees paid at settlement, plus the cost of any improvements to the property. Your basis can also be reduced by certain payments that represent a return of your cost, such as insurance payments for damage to the property or amounts received for granting an easement.
Property is removed from service when you stop using it to generate income. This may be because you sold the property, it’s destroyed, or you just decided to stop renting it.
The Modified Accelerated Cost Recovery System (MACRS) is used to depreciate property placed in service after 1986. There are also two different depreciation methods within MACRS – the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).
Most property is depreciated using the GDS, and you can recover the cost of residential rental property faster using this method. However, you can elect to use the ADS if you like.
If you want to use the ADS, you must elect to do so for residential rental property in the first year the property is placed in service. And you can’t change your mind and start using the GDS later.
[Note: If your rental property was placed in service before 1987, use either the Accelerated Cost Recovery System (ACRS), straight line, or declining balance depreciation method. See IRS Publication 534 for information about these methods.]
The amount you can deduct each year for depreciation on residential rental property depends on your cost basis in the property, the property’s recovery period, and when the property is placed in service.
As noted earlier, your “cost basis” is generally the price you paid for the property, including purchase-related expenses. If you make improvements to the property, those costs are depreciated separately.
A property’s recovery period is basically an estimate of its useful life. Recovery periods vary depending on the type of property and method of depreciation used. For residential rental property, the recovery period is 27.5 years if you’re using the GDS. If you’re using the ADS, the recovery period for residential rental property is 30 years (40 years for property placed in service before 2018).
If property is placed in service during the year, depreciation for the first and last year is prorated. The IRS uses something called a “convention” to determine the prorated amount. You must use the “mid-month convention” for residential rental property, which means all property placed in service or disposed of during any month is treated as if it was placed in service or disposed of at the midpoint of that month.
[Note: The IRS has various charts and tables in Publication 946 where you can find recovery periods, conventions, depreciation rates, and more for different types of property.]
To illustrate how these three components are used to calculate the annual deduction for depreciation of residential rental property, suppose you buy a house that you plan to rent on February 3 for $200,000. You also pay $20,000 in taxes and other closing costs at that time, which means your cost basis is $220,000 ($200,000 + $20,000). The house is ready to rent on March 20. However, since you must use the mid-month convention, March 15 is used as the in-service date. If you’re using the GDS, the property’s recovery period is 27.5 years.
In this situation, assuming you keep it as rental property, your estimated depreciation deductions for the property are as follows:
If you add up all the depreciation deductions over the years, you’ll see that it equals the property’s cost basis ($6,333 + $208,000 + $5,667 = $220,000).
What if you fence in the backyard for $2,000 (cost basis) a few years after buying the house? You’ll have to calculate the depreciation on that improvement separately. The recovery period for fencing is 15 years under the GDS. The fence is installed in October, and let’s assume the mid-quarter convention applies (i.e., the fence is treated as if it was placed in service at the midpoint of the quarter, which is November 15).
Assuming you don’t claim any special depreciation allowances, depreciation deductions for the fence will be approximately:
Again, the combined total of all depreciation deductions equals the fence’s cost basis ($2,000).
Your rental income and deductions – including for depreciation – are generally reported on Schedule E. However, you may have to use Schedule C instead to report depreciation on residential rental property if you provide certain services primarily for your tenant's convenience, such as regular cleaning, changing linens, or maid service.
You’ll also have to file Form 4562 if you’re depreciating property placed in service during the tax year.
Let a local tax expert matched to your unique situation get your taxes done 100% right with TurboTax Live Full Service. Your expert will uncover industry-specific deductions for more tax breaks and file your taxes for you. Backed by our Full Service Guarantee.
You can also file taxes on your own with TurboTax Premium. We’ll search over 500 deductions and credits so you don’t miss a thing.
