The depreciation schedule for residential rental property in the U.S. primarily follows a straight-line method over 27.5 years, typically at an annual rate of 3.636%. This allows property owners to recover the cost of the building and qualifying improvements over their useful life.
Understanding Rental Property Depreciation
Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over the time they use the property. For landlords, it's a crucial tax benefit, reducing taxable rental income by accounting for the wear and tear, deterioration, or obsolescence of the rental property structure. It's important to note that land is never depreciable; only the building and any capital improvements can be depreciated.
The Standard Depreciation Schedule: 27.5 Years
Under the Modified Accelerated Cost Recovery System (MACRS), U.S. residential rental property is categorized as 27.5-year property. This means its cost is recovered evenly over 27.5 years using the straight-line method.
- Depreciable Basis: This is the cost of the property minus the value of the land. It also includes certain settlement costs incurred when buying the property. For example, if you buy a rental property for $300,000 and the land is valued at $50,000, your depreciable basis for the building is $250,000.
- Annual Depreciation Rate: To calculate the annual depreciation, you divide the depreciable basis by 27.5 years. This equates to an annual depreciation rate of approximately 3.636% (1 / 27.5 years).
When Does Depreciation Begin?
Depreciation commences as soon as the property is placed in service or available to use as a rental. This means the property is ready and available for a tenant, even if it's temporarily vacant. You start depreciating from the month you place the property in service.
Calculating Annual Depreciation
The formula for calculating annual depreciation for residential rental property is straightforward:
Annual Depreciation = Depreciable Basis / 27.5 Years
Or, equivalently:
Annual Depreciation = Depreciable Basis × 0.03636
Example Depreciation Schedule
Let's illustrate with an example:
- Purchase Price of Property: $350,000
- Value of Land (non-depreciable): $75,000
- Depreciable Basis of Building: $350,000 - $75,000 = $275,000
Using the 27.5-year straight-line method, the annual depreciation would be:
$275,000 / 27.5 = $10,000 per year
This also aligns with $275,000 * 3.636% = $10,000 (approximately, due to rounding of the percentage).
Here's how a portion of the schedule might look:
| Year | Depreciable Basis (Start of Year) | Annual Depreciation | Accumulated Depreciation (End of Year) | Remaining Basis (End of Year) |
|---|---|---|---|---|
| 1* | $275,000 | $10,000 | $10,000 | $265,000 |
| 2 | $265,000 | $10,000 | $20,000 | $255,000 |
| 3 | $255,000 | $10,000 | $30,000 | $245,000 |
| ... | ... | ... | ... | ... |
| 27.5 | (Final period) | (Remaining amount) | $275,000 | $0 |
Note: The actual depreciation in the first year (and last year) might be prorated using the mid-month convention. This convention assumes that property is placed in service in the middle of the month, regardless of the actual date. Therefore, you only claim a half-month's depreciation for the month the property is placed in service.
Important Considerations for Depreciation
- Improvements: Significant improvements made to the property (e.g., a new roof, HVAC system) that add to its value or useful life are also depreciated. These are typically depreciated over the same 27.5-year period for residential property.
- Depreciation Recapture: When you sell a depreciated rental property, the IRS may "recapture" the depreciation you claimed. This means a portion of your gain on the sale may be taxed at a special depreciation recapture tax rate (currently 25%) up to the amount of depreciation you claimed.
- Record Keeping: Maintaining thorough records of your property's cost basis, improvements, and depreciation claimed each year is crucial for accurate tax reporting.
For more detailed information, consult official IRS resources such as IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes) and IRS Topic No. 704, Depreciation.
