Over How Many Years Is a Commercial Property Depreciated?

Depreciation allows businesses to recover the cost of certain assets over their useful life. For companies that own commercial property, understanding depreciation periods is important for financial planning and managing tax obligations. This accounting method helps spread the cost of a significant investment across the years it benefits the business.

Understanding Commercial Property Depreciation

Depreciation is an accounting concept that reflects the gradual decline in an asset’s value due to wear and tear, obsolescence, or use over time. In the context of commercial property, it serves as an IRS-approved tax deduction, enabling property owners to recover the cost of their investment over its useful life.

Land is not considered a depreciable asset because it generally does not wear out, become obsolete, or get consumed. Conversely, buildings and other improvements on the land, such as offices, retail spaces, warehouses, or factories, are tangible assets that do experience wear and tear, making them eligible for depreciation.

Commercial property encompasses real estate used in a trade or business or for the production of income. This includes a wide array of properties like office buildings, shopping centers, hotels, industrial buildings, and self-storage facilities. To qualify for depreciation, the property must be owned by the business, used in its operations or income-producing activities, have a determinable useful life, and be expected to last for more than one year.

The Standard Depreciation Period

The standard depreciation period for non-residential real property, commonly known as commercial property, is 39 years. This means that the cost of the building, excluding the value of the land it sits on, is spread out evenly as a tax deduction over 39 years.

The method used for tax depreciation in the United States for properties placed in service after 1986 is the Modified Accelerated Cost Recovery System (MACRS). Under MACRS, commercial real estate typically utilizes the straight-line depreciation method. This method involves taking an equal amount of the depreciable cost as a deduction each year over the 39-year period. For example, if a commercial building has a depreciable basis of $1,500,000 (after subtracting land value), the annual depreciation deduction would be approximately $38,462 ($1,500,000 divided by 39 years).

The straight-line method simplifies the calculation of annual depreciation, providing a consistent deduction over the asset’s recovery period. The IRS also applies a “mid-month convention” for commercial buildings, which means that regardless of when a property is placed in service during a month, it is treated as if it was placed in service in the middle of that month for depreciation calculation purposes.

Specific Situations and Components

While commercial property generally depreciates over 39 years, certain types of real estate and specific components within a commercial property have different depreciation schedules. Residential rental property, for instance, is depreciated over a shorter period of 27.5 years.

Certain land improvements associated with commercial property can be depreciated over a shorter period, typically 15 years, under MACRS. These improvements include elements like fences, parking lots, sidewalks, and landscaping. These assets are considered distinct from the main building structure and are subject to their own recovery periods, allowing for faster cost recovery.

Personal property located within a commercial building also has shorter depreciation periods. This category includes items such as machinery, equipment, furniture, and fixtures, which commonly have recovery periods of 5 or 7 years. Unlike real property, these assets may be eligible for accelerated depreciation methods, such as the Section 179 deduction or bonus depreciation. These provisions allow businesses to deduct a significant portion, or even the full cost, of qualifying personal property in the year it is placed in service, rather than spreading the deduction over several years.

Impact on Taxable Income

Depreciation impacts a commercial property owner’s taxable income by serving as a non-cash expense deduction. Each year, the allocated depreciation amount reduces the business’s taxable income, which in turn lowers its overall tax liability. The depreciation taken also reduces the property’s cost basis, which is its value for tax purposes.

When a commercial property that has been depreciated is later sold for a gain, a concept known as “depreciation recapture” comes into play. This tax rule requires that the previously deducted depreciation be reported as income upon the sale. The purpose of recapture is to recover the tax benefit received from the depreciation deductions.

For commercial real property (Section 1250 property), the recaptured depreciation is generally taxed at a maximum rate of 25%, distinct from standard capital gains rates. This means that a portion of the gain from the sale, up to the total amount of depreciation taken, may be subject to this specific tax rate.