Educational content only. Not tax, investment, or legal advice. Tax rules change and depend on your situation. Consult a licensed CPA or tax professional before acting. See full disclaimer.
Depreciation is the single largest non-cash deduction most rental investors claim. It reduces your taxable income without reducing the actual cash rent that hits your account. Understanding how to calculate it correctly is what separates hobbyists from investors who model true after-tax returns.
What is rental property depreciation?
The IRS treats a residential rental building as a depreciable asset with a useful life of 27.5 years. Each year, you deduct a portion of the building's cost from your rental income. This deduction is paper-only. You do not write a check for it. The building does not physically lose that value. It is simply a tax allowance that recognizes the property will eventually need replacement.
Land cannot be depreciated. It does not wear out. Before you calculate anything, you must separate the purchase price (or assessed value) into land and improvements.
Separating land from building value
There are three common ways to arrive at a land ratio. Pick the one most defensible for your deal and stick with it.
- Tax assessor split: Use the county assessor's land vs. improvement ratio from the most recent tax bill. This is the safest method if you are audited.
- Appraisal allocation: If you have a recent appraisal, use the appraiser's stated land and building values.
- Rule of thumb: Land is often 15 to 25 percent of total value in suburban single-family areas and 30 to 50 percent in dense urban cores. Use this only when no formal split exists.
The 27.5-year MACRS schedule
Residential rental property uses the General Depreciation System (GDS) with a recovery period of 27.5 years and the mid-month convention. Under the mid-month convention, the IRS treats property placed in service during any month as placed in service in the middle of that month. You get a half-month of depreciation for the month you buy and a half-month for the month you dispose.
The annual depreciation deduction is straightforward once you know the depreciable basis:
Annual Depreciation = Depreciable Basis / 27.5
Where Depreciable Basis = Purchase Price + Closing Costs + Immediate Capital Improvements - Land Value.
A concrete example
You buy a single-family rental for $350,000. Closing costs are $7,000. You spend $8,000 on immediate capital improvements (new HVAC, flooring) before placing it in service. The county assessor says land is 20 percent of value.
- Total cost basis: $350,000 + $7,000 + $8,000 = $365,000
- Land value (20%): $73,000
- Depreciable basis: $365,000 - $73,000 = $292,000
- Annual depreciation: $292,000 / 27.5 = $10,618 per year
That $10,618 is a deduction against rental income every year for 27.5 years. If you are in the 24 percent federal bracket, it saves you roughly $2,548 in taxes annually. That is real money that stays in your pocket.
How depreciation affects after-tax cash flow
Before-tax cash flow is what most calculators show: rent minus expenses minus debt service. After-tax cash flow is what you actually keep. Depreciation is the bridge between them.
Taxable Income = NOI - Interest - Depreciation
Tax Owed = Taxable Income x Marginal Tax Rate
After-Tax Cash Flow = Before-Tax Cash Flow - Tax Owed
Because depreciation is non-cash, it lowers your taxable income without lowering your actual cash flow. In years when depreciation pushes taxable income close to zero (or negative), you may pay little to no tax on rental income. This is why after-tax returns are often meaningfully higher than before-tax returns, especially in the early years of ownership.
ROIStack and after-tax modeling
ROIStack's LTR and STR analyzers model after-tax pro-forma metrics as first-class outputs, not an afterthought. The depreciation deduction flows directly into the after-tax cash flow calculation, so you see what a deal truly returns once the tax shield is included.
When you enter your purchase price, rehab budget, and financing terms, ROIStack:
- Separates depreciable basis from land value using your stated land ratio.
- By default, splits the building basis into a 25% short-life (cost-segregated) portion and a 75% long-life portion. The short-life portion gets 100% bonus depreciation in year 1; the long-life portion follows the 27.5-year straight-line MACRS schedule. Both percentages are adjustable per deal.
- Feeds depreciation into annual taxable income alongside interest and operating expenses.
- Computes after-tax cash flow, after-tax CoC, and after-tax IRR across the full hold period.
What qualifies as depreciable?
Only the building and certain capital improvements are depreciated over 27.5 years. Some items have shorter lives and can be depreciated faster (or expensed immediately under bonus depreciation or Section 179).
- 27.5-year property: building structure, roofing, HVAC, plumbing, electrical, flooring, kitchens, bathrooms.
- 5-year property: appliances, carpeting, furniture (residential).
- 15-year property: land improvements such as fences, driveways, landscaping, sidewalks.
- Expensed immediately: repairs that do not materially add value or extend useful life (e.g., patching a leak, repainting).
Common mistakes to avoid
- Depreciating land. Land is not depreciable. An auditor will disallow it.
- Using the wrong recovery period. Commercial property is 39 years, not 27.5.
- Forgetting closing costs and capital improvements in the basis. These increase your deduction.
- Expensing capital improvements as repairs. A new roof is an improvement, not a repair.
- Ignoring depreciation recapture when modeling an exit. It can add 25 percent to your effective tax bill on sale.