Depreciation for Investment Property Explained (2025 Guide)

Of all the tax benefits available to real estate investors, depreciation is arguably the most powerful. It’s a concept that allows you to generate positive cash flow from your rentals while legally reporting a smaller profit—or even a loss—to the IRS.

This deduction is essentially a "phantom expense." It reduces your taxable income, but no actual cash ever leaves your bank account. Understanding how it works is not just an accounting exercise; it's fundamental to maximizing your investment returns. This guide will walk you through the process step-by-step.

Step 1: Determine Your Cost Basis

Before you can depreciate anything, you need to know your starting point. Your cost basis is the total amount you’ve invested to acquire the property. It’s not just the purchase price.

Purchase Price + Certain Closing Costs = Initial Cost Basis

Closing costs you can typically include are:

Legal and recording fees
Title insurance
Transfer taxes
Surveys

Example: You buy a property for $350,000 and pay $10,000 in qualifying closing costs. Your initial cost basis is $360,000.

Step 2: Separate the Land from the Building

This is a critical step that many new investors miss: you cannot depreciate land. Land doesn't wear out or become obsolete, so the IRS doesn’t allow a deduction for it. You must separate the value of the land from the value of the building(s).

The easiest and most common way to do this is to use the property tax assessor's valuation from your local county. Their statement will typically show separate values for land and improvements (the building).

Initial Cost Basis - Land Value = Depreciable Basis

Example: Your tax assessment shows the land is worth $80,000. Your depreciable basis is $360,000 - $80,000 = $280,000. This is the number you will use for your calculations.

Step 3: Know the Recovery Period (Useful Life)

The IRS dictates how long you can depreciate a property. This is known as the "recovery period" or "useful life." The system used is called the Modified Accelerated Cost Recovery System (MACRS).

For real estate, the rules are straightforward:

Residential Rental Property: 27.5 years
Commercial Property: 39 years

You will depreciate your property in equal installments over this period using the straight-line method.

Step 4: Putting It All Together - The Calculation

Now you have all the pieces to calculate your annual depreciation deduction.

Depreciable Basis / Recovery Period = Annual Depreciation Deduction

Example: You have a residential rental property with a depreciable basis of $280,000.

$280,000 / 27.5 years = $10,182

This means you get to deduct $10,182 from your rental income every single year for 27.5 years. If your property generated $15,000 in net income before depreciation, your taxable income is now only $4,818 ($15,000 - $10,182).

A Quick Word on Depreciation Recapture

When you sell your property, the IRS wants to "recapture" the taxes you saved. The total amount of depreciation you’ve claimed over the years will be taxed at a special depreciation recapture rate, which is capped at 25%. While this means you will have a tax bill upon sale, the benefit of deferring those taxes and improving your cash flow for years—or even decades—is an incredibly powerful wealth-building tool.

Conclusion: The Power of a Phantom Expense

Depreciation is the engine of tax-efficient real estate investing. By understanding and properly applying this concept, you can significantly increase your after-tax returns and accelerate your portfolio growth. It’s a paper expense that creates real-world cash savings year after year.

Internal Link Idea: To learn how to accelerate these deductions even further, read our [Cost Segregation 101: A Beginner's Guide].