The non-cash tax deduction that shelters rental income.
Depreciation is a non-cash tax deduction that allows real estate investors to deduct the cost of a property's building (excluding land) over a defined useful life — 27.5 years for residential rental, 39 years for commercial. Depreciation creates a paper expense that shelters rental income from taxation, often producing tax losses even when cash flow is strongly positive.
Depreciation is the single biggest tax advantage real estate investors enjoy. A property generating $40,000 of NOI might also produce $30,000 of annual depreciation deduction — turning a $40k cash flow into a $10k taxable income (or even a loss). The mortgage interest deduction adds more shelter. The result: many real estate investors show consistent tax losses even while cash flows are strong.
Residential rental property depreciates over 27.5 years under straight-line. Commercial property depreciates over 39 years. Land does not depreciate (it doesn't "wear out"), so the depreciable basis is total cost minus a reasonable land allocation — typically 15–25% of price for typical urban/suburban properties.
Cost segregation studies accelerate depreciation by identifying components of the property that have shorter useful lives than the building itself — appliances, carpeting, HVAC, fences, parking lot, landscaping. Items with 5, 7, or 15-year lives can be depreciated faster than the 27.5/39-year structure, producing larger early-year deductions. A cost seg study costs $5k–$15k typically and produces $30k–$150k+ of accelerated deductions on a mid-market property.
The trade-off comes at sale via depreciation recapture. When a depreciated property is sold, the IRS taxes the depreciation you took at a 25% federal rate (plus state) — recapturing the tax benefit you previously enjoyed. The 1031 exchange defers this recapture; selling outright pays it. Most sophisticated investors plan around the depreciation/recapture trade — using depreciation to shelter ordinary income now, then either holding indefinitely or exchanging at sale.
| Purchase price | $485,000 |
| Land allocation (20%) | $97,000 |
| Depreciable basis | $388,000 |
| Useful life (residential) | 27.5 years |
| Annual depreciation | $14,109 |
| Property NOI | $32,400 |
| Mortgage interest deduction | $23,800 |
| Taxable income (NOI – interest – depreciation) | ($5,509) – tax loss |
A non-cash tax deduction that allows real estate investors to deduct the cost of a property's building over its useful life — 27.5 years for residential rental, 39 years for commercial. Land is not depreciable.
Annual depreciation = (purchase price – land value) ÷ 27.5 years (residential) or 39 years (commercial). On a $400k residential rental with 20% land allocation, that's ~$11,600/year of depreciation deduction.
An engineering study that identifies components of a property with shorter useful lives than the structure itself (appliances, carpet, HVAC, parking). Allows accelerated depreciation, producing larger early-year deductions.
When a depreciated property is sold, the IRS taxes the depreciation previously taken at a 25% federal rate (plus state). The 1031 exchange defers this recapture; outright sale triggers it.
Yes — depreciation + mortgage interest + operating expenses often produce a tax loss even on positive cash flow properties. Passive loss rules limit how that loss can be used against other income, with exceptions for real estate professionals and active managers.
Matrix structures rental and bridge loans aligned with your depreciation, 1031, and hold strategy — capital that fits your overall plan.
