How to Calculate Rental Property Depreciation: IRS 27.5-Year MACRS Guide

Depreciation is one of the most powerful tax advantages available to real estate investors. Under IRS Publication 527, landlords can deduct the non-cash physical wear-and-tear of a residential building against rental income, creating a "tax shelter" where positive cash flow is shielded from federal and state income taxes.

This guide explains how to establish depreciable cost basis, separate land value, calculate annual straight-line MACRS deductions, and connects to the CalculatorAll Real Estate Depreciation Calculator.

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The IRS Depreciation Formulas

1. Depreciable Building Basis Formula

Depreciable Basis = (Purchase Price + Qualifying Acquisition Closing Costs + Capital Improvements) - Land Value

(Note: The IRS explicitly prohibits depreciating land because raw land does not wear out or lose value over time).

2. Annual Straight-Line Depreciation

• Residential Real Estate (27.5-Year Recovery Period): Annual Depreciation = Depreciable Basis / 27.5 = Depreciable Basis × 3.636% per year
• Commercial Real Estate (39-Year Recovery Period): Annual Depreciation = Depreciable Basis / 39 = Depreciable Basis × 2.564% per year

3. Annual Income Tax Shield Savings

Annual Tax Savings = Annual Depreciation Deduction × Investor Marginal Tax Rate

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Worked Example: $450,000 Residential Rental

Suppose you purchase a residential single-family rental for $450,000. The county tax assessor allocates 20% ($90,000) to land and 80% ($360,000) to the physical structure:

1. Calculate Depreciable Basis: $450,000 - $90,000 = $360,000.
2. Calculate Annual Depreciation Deduction: $360,000 / 27.5 = $13,090.91 per year ($1,090.91/month).
3. Calculate Tax Savings (at 32% marginal tax bracket): $13,090.91 × 0.32 = $4,189.09 in direct annual tax savings.

If the property generates $10,000 in net pre-tax cash flow, claiming the $13,090.91 depreciation deduction produces a paper tax loss of -$3,090.91, resulting in $0.00 owed in taxes on that $10,000 cash income.

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What is Depreciation Recapture Upon Sale?

When you eventually sell the property, the IRS taxes all cumulative depreciation claimed (or allowable) at a flat 25% depreciation recapture tax rate, unless you defer taxes indefinitely using an IRC Section 1031 Like-Kind Exchange.