How does depreciation work on a residential rental property?

Depreciation lets you deduct the cost of your rental building a little at a time, every year, even though you aren't spending that money each year. It's one of the biggest tax benefits of owning a rental.

A simple example
Say you buy a rental for $300,000, and $60,000 of that is the land. The building is worth $240,000. Spread over 27.5 years, that's about $8,700 you can deduct each year. That deduction lowers the rental income you pay tax on.

How it works

• The building's cost is spread over 27.5 years.
• Land doesn't wear out, so it can't be depreciated. Your property tax bill often shows a land and building split you can use as a starting point.
• Depreciation starts when the home is ready and available to rent, not when you bought it.
• Big improvements, like a new roof or furnace, are added and depreciated too.
• If the home used to be where you lived, special rules decide the starting value.

Can I deduct it all in the first year?
Not the building itself. It has to be spread out, and your first year is only partial, based on the month the rental starts. But some items can be deducted much faster. Appliances, carpet, furniture, and outdoor improvements like a fence often qualify to be deducted in full the year they're bought and put into use.

When you sell
The depreciation you took is taxed when you sell, at up to 25%. This applies even if you forgot to claim it, so make sure it's claimed every year.

Other options worth considering

• Keep good records from the start: your purchase closing statement, receipts for improvements, and the date the home became available to rent.
• Know the difference between a repair and an improvement. A repair, like fixing a leak, can usually be deducted right away. An improvement, like a new roof, is deducted over time.
• Deduct your other rental costs too, such as mortgage interest, property taxes, insurance, repairs, and management fees.
• If your rental shows a loss on paper, there are limits on using it to lower taxes on your other income, depending on your income and how involved you are.
• Thinking about selling someday? Ask about a 1031 exchange, which can let you put off the tax if you reinvest in another rental property.