How Does House Depreciation Work for Rental Properties?

Rental property owners can benefit from depreciation, a tax deduction that accounts for the gradual wear and tear of a property. This reduces taxable income, potentially saving thousands of dollars annually. Understanding depreciation is essential to comply with IRS rules and maximize tax benefits.

Eligibility for Depreciation

To qualify for depreciation, a rental property must meet IRS requirements. The property must be owned by the taxpayer, used to generate income, and have a determinable useful life, meaning it will eventually wear out. It must also be expected to last more than one year—shorter-lived assets are typically deducted as expenses.

Only the physical structure of the rental property is depreciable, not the land. The IRS considers land an asset that does not deteriorate, so its value must be excluded when calculating depreciation. Property tax assessments often separate land and structure values, which can help determine the depreciable amount. If this breakdown is unavailable or inaccurate, an independent appraisal may be needed.

Depreciation starts when the property is placed in service, meaning it is ready and available for rent. If a property is purchased but remains vacant while being prepared for rental, depreciation cannot begin until it is actively listed. This rule prevents deductions on properties that are not generating income.

Calculating the Depreciable Basis

The depreciable basis is the portion of a property’s value that can be written off over time. This is generally based on the purchase price but must exclude non-depreciable costs. Since land does not wear out, its cost must be subtracted from the total acquisition price.

Certain acquisition-related costs can be included in the depreciable basis. Settlement fees such as title searches, legal fees, and recording charges may qualify if they directly relate to obtaining ownership of the building. If major repairs are required before the property is placed in service, those costs may need to be capitalized and added to the basis rather than deducted immediately.

Significant improvements—such as a new roof, upgraded plumbing, or an expansion—must be added to the depreciable basis rather than deducted in the year incurred. If the property sustains damage and an insurance payout is received, the basis must be reduced accordingly. Keeping accurate records of these changes ensures depreciation calculations remain correct.

Recovery Period

The IRS sets the recovery period for residential rental properties at 27.5 years under the Modified Accelerated Cost Recovery System (MACRS). Depreciation is applied using the straight-line method, meaning the same amount is deducted each year.

Depreciation begins in the month the property is placed in service. The IRS requires the mid-month convention for residential rental property, meaning only half a month’s depreciation is allowed in the first and last year. For example, if a rental home with a depreciable basis of $250,000 is placed in service in July, only 5.5 months of depreciation can be claimed that year. This results in an annual deduction of approximately $9,091 ($250,000 ÷ 27.5), but only $4,545 in the first year due to the mid-month convention.

If a property is taken out of service, such as being converted to personal use or sold, depreciation stops. However, if it is temporarily vacant between tenants, depreciation continues as long as it remains available for rent. Failing to claim depreciation when required can lead to tax inefficiencies, while continuing to depreciate a property no longer in service can create compliance risks.

Adjusting for Home Improvements

When a rental property is upgraded, tax treatment depends on whether the costs qualify as improvements or routine repairs. The IRS distinguishes between these categories based on whether the expenditure adds value, prolongs the property’s useful life, or adapts it to a new use. Improvements must be capitalized and depreciated, while repairs can typically be deducted in the year incurred. For example, replacing a broken windowpane is a repair, but installing all-new energy-efficient windows is an improvement requiring capitalization.

Major structural additions, such as a new garage or expanded living space, are added to the building’s depreciable basis and depreciated over the same 27.5-year period as the original structure. However, certain assets, like appliances, carpeting, or roofing, may have different recovery periods under IRS rules. A new HVAC system typically follows a 27.5-year schedule, while a dishwasher or refrigerator may qualify for a shorter five-year depreciation period under MACRS.

Ending Depreciation

Depreciation ends when the full recovery period has elapsed, the property is sold, or it is permanently removed from rental use. Each scenario has different tax implications.

If a property reaches the end of its 27.5-year recovery period, no further depreciation deductions can be claimed. If the property is sold before this period is completed, depreciation must be accounted for in the sale. The IRS requires landlords to recapture depreciation, meaning any deductions previously taken reduce the property’s adjusted cost basis. This can lead to depreciation recapture tax, which is taxed as ordinary income up to a maximum rate of 25%.

For example, if a rental home was purchased for $300,000 and $50,000 in depreciation was claimed over time, the adjusted basis would be $250,000. If the property is later sold for $350,000, the taxable gain would be calculated based on this adjusted basis, with $50,000 subject to depreciation recapture rules.

If a rental property is converted to personal use, depreciation stops when it is no longer available for rent. However, prior depreciation still affects future tax calculations if the property is later sold. The adjusted basis remains reduced by the depreciation deductions taken, which can increase taxable gains upon sale. Property owners considering a conversion should evaluate the tax consequences, as they may lose the ability to offset rental income while still facing depreciation recapture later. Keeping detailed records of all depreciation claimed ensures accurate reporting and helps avoid miscalculations that could trigger IRS scrutiny.