Rental Property Depreciation: How to Calculate & Examples

Rental property depreciation is the process of deducting the cost of your rental property over time. With it, investors in income-producing property can deduct the cost of the asset over a series of tax years; the cost of land is not depreciated. The annual depreciation deduction is based on two factors:

1. Your basis in the property; usually the purchase price
2. Whether the rental property is commercial or residential

Depreciation of rental property stops when either the asset is no longer used or its basis has been fully recovered. This means that for a domestic piece of residential real estate, there would no longer be a depreciation deduction to take on that piece of property after 27.5 years.

How to Calculate Rental Property Depreciation

Step 1: Determine the Initial Basis of the Property

The process for determining your initial basis in the rental property depends on how the property was acquired.

Assets are depreciated over the period that they are expected to remain useful. Since land is considered to remain useful indefinitely, it is not depreciated—so you must separate the basis of the building from the basis of the land.

The primary ways of obtaining property are listed below:

• Purchased property: The initial basis of rental property is equal to what you paid for it. The cost includes both the purchase price and any closing costs. Points paid to a mortgage company should not be included but instead amortized over the life of the mortgage.
• Inherited property: Your adjusted basis of inherited property held for rent is the fair market value (FMV) of the property on the date of death.
• Gifted property: If you received your rental property as a gift, your adjusted basis is equal to the adjusted basis that the donor had at the time of the gift. You’ll need a copy of the donor’s depreciation records to determine this amount.
  • To calculate the adjusted basis, take the original cost and subtract the amount of depreciation the donor claimed. If the FMV of the property is less than the donor’s adjusted basis, then your adjusted basis is equal to the FMV.

  Regardless of how you acquired your rental property, the initial basis calculated above can be increased by the amount spent to prepare the property to be rented for the first time. Repair and maintenance costs incurred to prepare the property for subsequent tenant rentals are fully deductible in the year incurred.

  Step 2: Determine if Rental Property Is Residential or Commercial

  The depreciation deduction can be claimed for any rental property, regardless of location, as soon as it is placed in service. Under the MACRS

  Modified Accelerated Cost Recovery System , depreciation for rental property:

  • Within the US is calculated using 27.5 years for residential rental properties and 39 years for commercial rental properties
  • Outside of the US is calculated over a 30- or 40-year period, depending on when it was first rented and if it is designated for commercial or residential use; you can find more information on depreciation for foreign rental properties in IRS Publication 946.

  Types of Depreciable Real Estate

  Here are some typical examples of the property types that fall into residential or commercial rental property: