Rental Property Depreciation
Tax deduction for wear and tear on rental property; residential: 27.5 years, commercial: 39 years.
Key Takeaways
- Depreciation is a tax deduction for the "wear and tear" of your rental property
- US residential properties: depreciated over 27.5 years using straight-line method
- US commercial properties: depreciated over 39 years
- Canada: Capital Cost Allowance (CCA) at varying rates
- Depreciation is "recaptured" when you sell the property - you pay tax on the deductions
What is Rental Property Depreciation?
Depreciation is a tax deduction that allows rental property owners to recover the cost of their investment over time. Think of it as accounting for the natural wear and tear, deterioration, and obsolescence of your property as it ages.
Each year, you can deduct a portion of the property's cost from your taxable rental income, which reduces your overall tax liability. One of the biggest tax benefits of owning rental property.
How Depreciation Works in the US
Residential Rental Property
For residential rental properties (apartments, houses, condos), the IRS requires you to use the straight-line depreciation method over 27.5 years. This means you deduct an equal portion of the property's basis each year.
Commercial Property
Commercial properties (office buildings, retail space, warehouses) are depreciated over 39 years using the straight-line method.
Source: IRS Publication 946 - How to Depreciate Property
Calculating Depreciation
To calculate your annual depreciation deduction:
Annual Depreciation = (Property Basis - Land Value) / Recovery Period
Important: Land is not depreciable. You must separate the cost of the land from the cost of the building and improvements.
Example
You buy a rental property for $300,000, with the land valued at $50,000 and the building valued at $250,000.
Annual depreciation = $250,000 / 27.5 = $9,090.91 per year
Each year, you can deduct $9,090.91 from your taxable rental income.
Bonus Depreciation
Bonus depreciation allows you to deduct a larger portion of the cost in the first year. After the Tax Cuts and Jobs Act of 2017, bonus depreciation was increased to 100% for qualified property placed in service between September 27, 2017, and December 31, 2022. The percentage phases down after that.
This applies to improvements and personal property (like appliances), not the building itself.
Depreciation Recapture
When you sell a rental property, you may have to pay depreciation recapture tax. This means you pay tax on the depreciation deductions you've taken over the years, even if you have a loss on the sale.
In the US, depreciation recapture is taxed at a maximum rate of 25%, plus any additional capital gains tax on the remaining gain.
Canada: Capital Cost Allowance (CCA)
In Canada, depreciation is called Capital Cost Allowance (CCA). The rules are different:
- Class 1 (buildings): 4% declining balance method
- Class 3 (brick/stone buildings): 5% declining balance
- Class 8 (furniture/appliances): 20% declining balance
Source: Canada Revenue Agency - Capital Cost Allowance
Benefits of Depreciation
- Reduces Taxable Income: Depreciation deductions lower your taxable rental income
- Cash Flow Improvement: Lower taxes mean more cash in your pocket
- Paper Losses: Depreciation can create paper losses that offset other income
Calculating Your Depreciation Deduction
Want to estimate your annual depreciation deduction and tax savings? Use our rental property calculator:
AllMoneyCalc - Rental Property Calculator