What Landlords Need to Know About Depreciation and Property Value

Key Takeaways

• Depreciation boosts ROI: Landlords can use depreciation to recover the cost of a rental property over time, reducing taxable income.

• Eligibility matters: Only income-producing properties with a determinable useful life qualify for depreciation deductions.

• Professional help pays off: Working with experts like Real PM Services helps landlords stay compliant while maximizing financial benefits.

Depreciation is a word you will encounter at some point in your journey as a property investor. 

Learning how depreciation impacts your ability to maximize tax benefits on your rental while also complying with IRS (Internal Revenue Service) regulations is vital for the success of your investment property. 

Depreciation is one of a landlord’s most important tax-deductible expenses. It allows you to deduct the cost of your rental property plus the cost of any improvements made to the property over a long period of time. 

For residential real estate, you can deduct this cost over the course of 27.5 years, and 39 years for commercial real estate. This is known as the asset’s recovery period.

Depreciation is based on the idea that, over time, the value of an asset gradually declines due to wear and tear. This gradual loss in value continues throughout the useful life of the asset until its value reaches zero. Since property taxes are based on a property’s assessed value, the loss in the market value of a property must be accounted for when calculating property taxes.

As a property owner, as long as you are generating rental income from the property, you are allowed to claim depreciation on that property. You can claim this deduction every year when you file your tax returns until you either sell the property or the entire cost of the asset has been recovered. 

So, how do you depreciate a rental property? The team at Real PM Services is here with the answers. 

Rental Property Depreciation Explained: What Every Landlord Should Know

Depreciation: Eligibility Requirements for Rental Properties

To be eligible for depreciation, your rental property must meet the following conditions:

1. You must own the property outright, even if it is carrying a mortgage. Property managers, renters, or lessees do not qualify for depreciation deductions.
2. The property must be an income-producing activity, such as a business or rental operations. Your personal home or vacation home is not eligible for depreciation.
3. The property has a determinable useful life – it must be something that wears out, decays, or loses value with time.
4. The property has a useful life of more than one year. To be eligible, the property must bea rental or business premises for at least one year.
5. The property has one or more permanent structures. You cannot depreciate bare land because it does not have a determinable useful life that wears out over time.

The Two Systems for Depreciating a Rental Property

Depreciation starts to count when a rental property becomes ready for rent. The IRS uses what is known as the Modified Accelerated Cost Recovery System (MACRS) to calculate depreciation on rental properties. This system is further subdivided into two systems.

The two variants of the MACRS are the General Depreciation System (GDS), used by most rental properties, and the Alternative Depreciation System (ADS). Landlords may choose to use the GDS or ADS, but this decision is irreversible; it can’t be unmade throughout the useful life of the asset.

The General Depreciation System (GDS)

Unless a property owner elects to use the ADS, the GDS is the standard method for residential rental properties. It employs the straight-line depreciation method (depreciation deductions are the same for each year) with a standard recovery period of 27.5 years or 330 months.

The Alternative Depreciation System (ADS)

The ADS uses a longer recovery period of 30 years (40 years if the entire investment property was placed in service before Dec. 31, 2017). Properties under the ADS have smaller deductions than those in the GDS. The ADS also uses the straight-line depreciation method and is mostly used by:

• Properties that are used predominantly outside the US
• Properties that are used by a tax-exempt entity
• Properties financed with the proceeds of tax-exempt bonds
• Properties that have a qualifying business used 50% of the time or less
• Properties that are owned by certain types of businesses, such as a REIT
• Properties that are mostly used for farming

How to Depreciate a Rental Property

To depreciate your rental property, follow this 3-part process:

• Calculate the property’s cost basis
• Calculate the depreciable basis
• Determine annual depreciation

Step 1: Determine Your Cost Basis

This is the purchase price of the property plus the capitalized costs of the mortgage.  The cost basis for the property also includes any improvements made to the property before placing it in service or shortly afterwards. What are the costs that go into cost basis calculations?

They include things like abstract fees, legal fees, recording fees, transfer taxes, title insurance, surveys, utility installation fees, maintenance costs. and all items included in the closing costs. When calculating the cost basis, it is also important to know the distinction between repairs and improvements.

While improvements seek to enhance the value of the investment property, extend its useful life, or adapt it for new uses, repairs seek to maintain the property in its current state by restoring it to its normal operating condition. Basically, improvements increase the property’s overall value; repairs don’t.

Step 2: Calculate the Depreciable Basis

This is the cost of the property minus the assessed value of the land (land is non-depreciable). Local tax assessment records provide land-to-building ratios that can be used to derive the value of land. 

The value of the land can also be obtained through professional land appraisal. Investors may also use an 80% building and 20% land split, but this approach may be subject to scrutiny by the IRS. Once you know the depreciable value of your property, you may proceed to the next step.

Step 3: Determine Annual Depreciation

This is as simple as dividing the depreciable basis by the recovery period. For rental properties using the GDS method, the recovery period is 27.7 years. Divide the depreciable basis by 27.5 to get your annual depreciation deduction. 

Alternatively, the IRS can tell you the percentage of depreciation expense you can claim each year. In most cases, this is 3.636%.

Bottomline

Real estate depreciation is a complex subject that can take years to master. Understanding depreciation is just one part of running a profitable rental business. Managing tenants, maintenance, and finances takes time and expertise. 

That’s where Real PM Services comes in. 

Our experienced property management team helps landlords maximize returns while staying compliant with tax and legal requirements. From rent collection and accounting to property maintenance and detailed financial reporting, we make ownership easier and more profitable.