What Qualifies for Bonus Depreciation on a Rental Property?
For rental property owners, bonus depreciation applies not to the building, but to its components and improvements, creating important tax considerations.
Bonus depreciation is an accelerated deduction that permits property owners to write off a portion of an asset’s cost in its first year of use. This tax incentive encourages business investment by providing an immediate tax benefit. For rental property owners, it is a method to lower taxable rental income by taking a large, upfront depreciation expense on certain qualifying assets. The rules for this deduction are outlined by the Internal Revenue Service (IRS) and have seen recent changes.
Determining Property Eligibility for Bonus Depreciation
An asset’s eligibility for bonus depreciation depends on its recovery period. Only property with a Modified Accelerated Cost Recovery System (MACRS) recovery period of 20 years or less qualifies. This rule excludes the main structure of a residential rental building (27.5-year recovery period) and commercial buildings (39-year recovery period). These long-lived assets must be depreciated over their standard life instead of using the accelerated deduction.
While the building itself does not qualify, many components and improvements do. Tangible personal property with a 5 or 7-year recovery period is eligible. This includes items like new appliances, furniture used in a furnished rental, and new carpeting. These items are not considered a permanent part of the building and are depreciated separately.
Land improvements are another category of qualifying property. These are assets attached to the land, not the building, and have a 15-year recovery period. Examples include new fences, landscaping projects, and the paving of parking lots or sidewalks. Because their recovery period is under 20 years, these improvements are eligible for bonus depreciation.
A distinction must be made between a capital improvement and a simple repair. An improvement enhances a property’s value, extends its useful life, or adapts it to a new use, and its cost is capitalized for depreciation. In contrast, a repair maintains the property’s current condition and is deducted as a current-year operating expense. Only capital improvements are eligible for bonus depreciation.
Calculating and Claiming Bonus Depreciation
The bonus depreciation percentage is set by federal law and is being phased out. For qualified property placed in service in 2025, the rate is 40%. This rate drops to 20% for property placed in service in 2026 and is eliminated in 2027. The deduction is calculated by multiplying the asset’s cost by the applicable rate.
For example, a landlord who purchases and installs $15,000 worth of new appliances and carpeting in 2025 can claim a bonus depreciation deduction of $6,000 ($15,000 x 40%). This $6,000 is deducted from rental income in the first year. The remaining $9,000 cost basis is then depreciated over its regular MACRS recovery period, such as 5 years for appliances.
Taxpayers claim this deduction by filing IRS Form 4562, Depreciation and Amortization, with their annual tax return. The form requires listing the qualifying property, its cost, and the calculated bonus amount.
Taking bonus depreciation is automatic for qualifying property unless the taxpayer elects out. To opt out, a taxpayer must attach a statement to their timely filed tax return for the year the property was placed in service. This choice might be made if a taxpayer expects to be in a higher tax bracket in future years and prefers to spread out depreciation deductions.
Special Considerations for Rental Property Owners
When a depreciated asset is sold, the owner may face depreciation recapture. This IRS rule requires treating the gain on the sale as ordinary income, up to the total amount of depreciation claimed. For instance, if an owner claimed $6,000 in bonus depreciation on appliances and later sells them at a gain, that portion of the gain would be taxed at their regular income tax rate instead of the capital gains rate.
A complication for many rental property owners is that most states do not conform to federal bonus depreciation rules. This means a large deduction taken on a federal return may be disallowed for state tax purposes. Taxpayers in these states must perform a separate depreciation calculation for their state return, adding back the federal bonus amount and then calculating depreciation according to state-specific schedules. This creates a difference between federal and state taxable income.
Certain real estate businesses may elect to be treated as a “real property trade or business.” This election allows the business to deduct all of its business interest expense without limitation. The trade-off is that the business gives up the ability to claim bonus depreciation on its nonresidential real property, residential rental property, and qualified improvement property. However, the business can still claim bonus depreciation on other qualifying assets, like tangible personal property and land improvements. This choice requires property owners to weigh the benefit of unlimited interest deductions against the loss of accelerated depreciation.