Do Buildings Depreciate? A Look at How It Works

Depreciation generally refers to the decrease in an asset’s value over time. For buildings, this concept carries several different meanings, depending on whether one is considering the physical wear and tear or the financial accounting treatment. Buildings can experience a reduction in their actual worth due to aging, and they can also be subject to a systematic allocation of their cost for financial and tax reporting.

Understanding Physical vs. Accounting Depreciation

Physical depreciation describes the actual decline in a building’s market value or usefulness due to wear and tear, deterioration, and obsolescence. Examples include an aging roof that requires replacement, outdated heating, ventilation, and air conditioning (HVAC) systems that are less efficient, or a deteriorating foundation. These physical changes directly impact a building’s condition and appeal.

Accounting depreciation, often called tax depreciation, is a non-cash expense used to spread the cost of a tangible asset over its useful life. It is primarily used for financial reporting and tax purposes, and it does not necessarily reflect the building’s current market value or physical condition. While physical depreciation is about a building’s actual decline in worth, accounting depreciation is a structured way to expense its cost over time on financial statements.

Tax Depreciation for Buildings

Buildings used for business or income-producing activities, such as rental properties, are eligible for tax depreciation in the U.S. The Modified Accelerated Cost Recovery System (MACRS) is the primary method mandated by the Internal Revenue Service (IRS) for most real estate placed in service after 1986. Under MACRS, the capitalized cost of tangible property is recovered through annual deductions.

MACRS assigns specific “useful lives,” or recovery periods, to different types of real property. Residential rental property is depreciated over 27.5 years. Nonresidential real property, which includes commercial buildings like offices, retail stores, and warehouses, has a longer recovery period of 39 years. This depreciation reduces the property owner’s taxable income.

The depreciation deduction is computed using the straight-line method for real property under MACRS, applying a “mid-month convention.” This convention means that property placed in service during any month is considered to have been placed in service in the middle of that month, regardless of the actual date. For instance, a property placed in service in January would be allowed 11.5 months of depreciation for the first recovery year.

Key Considerations for Building Depreciation

Land itself is not depreciable. Only the building structure and certain permanent improvements are eligible for depreciation. This requires the property’s overall cost basis to be allocated between the land and the building. Taxpayers must determine the portion of the purchase price attributable to the building, as only that amount can be depreciated.

The “cost basis” for depreciation is the purchase price of the property, plus acquisition costs and capital improvements, minus the value assigned to the land. For example, if a property is purchased for $500,000 and the land is valued at $100,000, the depreciable basis for the building would be $400,000.

The “placed-in-service date” marks the starting point for calculating depreciation. This is the date when the property is ready and available for its intended use, whether for business or income-producing activity. It is not necessarily the purchase date but the date it becomes operational. Buildings used for personal purposes, such as a primary residence, are not eligible for tax depreciation.