11 Depreciation Expense Rules Real Estate Investors Must Know in 2026

Your real estate portfolio could be missing out on valuable depreciation expense benefits. The right understanding of these tax rules makes the difference between profit and loss on your balance sheet.

Depreciation offers real estate investors the most important tax advantages through non-cash expenses. You can deduct up to $25,000 in passive losses against your ordinary income if your modified adjusted gross income (MAGI) stays at $100,000 or less. The deduction starts to decrease by 50% of the amount that your MAGI goes over $100,000. The allowance goes away completely once your income hits $150,000.

You need to calculate depreciation expense correctly and understand its formula. Keeping accurate depreciation expense journal entries helps you use the fact that depreciation is a non-cash expense to your advantage. The rules might seem complex, but becoming skilled at them is crucial to your long-term investment strategy.

Let’s explore 11 critical depreciation rules you should know before 2026. Several tax provisions will change then. These insights will help you get the maximum tax benefits while following IRS regulations, whether you’re an experienced investor or just starting to build your real estate portfolio.

Depreciation Is a Non-Cash Expense

Depreciation expense is a crucial concept you need to grasp to maximize your real estate investment returns. Most business expenses need actual cash payments. Depreciation works differently – it’s a powerful accounting tool that doesn’t require you to spend money.

Depreciation is a non-cash expense explained

Depreciation gives you an annual income tax deduction that helps you recover your investment property’s cost over time. This accounting tool recognizes that property value goes down because of wear and tear, age, and obsolescence. The key difference: you don’t spend any cash each year to claim this deduction.

The IRS recognizes that assets lose value through normal use, even as your property’s market value might go up. This “paper loss” becomes a valid expense against your property income without needing you to spend money.

The IRS says your property must meet these requirements to qualify for depreciation:

• You must own the property
• It must be used for business or income-producing activities
• It must have a determinable useful life
• It must be expected to last more than one year

On top of that, land value stays out of depreciation calculations because land doesn’t “wear out”.

Why it matters for real estate investors

Real estate investing offers unique tax advantages through depreciation. You can offset rental income with a non-cash expense, which creates a tax shelter for your positive cash flow.

This tax benefit can lower—or sometimes eliminate—taxable income on rental profits. Sometimes, when depreciation creates a paper loss, you might deduct it against other income sources. This means you get real tax savings from a theoretical expense.

Here’s an example: Let’s say you buy a residential rental property for $1,000,000 with land value of $175,000. Your annual depreciation would be $30,000 ($825,000 building value ÷ 27.5 years). This big deduction cuts your taxable income each year.

What it means for your taxable income

Depreciation can make a big difference in your taxable income. To cite an instance, see a property that makes $30,000 in pretax income. It would show only $25,000 in taxable income after a $5,000 depreciation expense. At a 20% tax rate, your tax bill drops from $6,000 to $5,000—saving you $1,000 yearly without spending anything.

Sometimes, depreciation can exceed your property’s income. Picture a multifamily property that generates $50,000 in cash flow with $30,000 in annual depreciation. This is a big deal as it means that your taxable income drops sharply, creating highly tax-efficient income streams.

All the same, note that the IRS will eventually “recapture” some of these benefits when you sell the property. They tax previous depreciation deductions at up to 25%. Even with recapture taxes, knowing how to defer taxation and reinvest those savings over many years offers major financial benefits.

The Straight-Line Depreciation Method

The straight-line method is the life-blood of real estate depreciation. It helps you recover investment costs through equal annual tax deductions. Your tax planning becomes predictable and record-keeping stays simple with this investment approach.

Straight-line depreciation formula

The formula to calculate straight-line depreciation is simple:

Annual Depreciation = (Cost of Asset – Salvage Value) ÷ Useful Life

Real estate investors should know these specific components:

• Cost of Asset: Your original purchase price plus eligible closing costs and capital improvements
• Salvage Value: In real estate, this represents the land value, which cannot be depreciated
• Useful Life: The IRS-designated recovery period (27.5 years for residential rental properties and 39 years for commercial properties)

How to calculate depreciation expense

Here’s how you can calculate depreciation expense for your investment property:

1. Add the purchase price, eligible closing costs, and capital improvements to determine your property’s cost basis
2. Take out the land value from your cost basis since land does not depreciate
3. Take the remaining amount (building value) and divide it by the recovery period

Let’s look at a real-life example: You buy a residential rental property for $180,000. The land value is 15% of the total ($27,000), which makes your depreciable basis $153,000. Your annual depreciation expense comes to $5,563.64 after dividing by 27.5 years.

You can also multiply your depreciable basis by 3.636% (1/27.5) to get the same annual depreciation expense.

When to use this method

Current tax law requires the straight-line method for real estate depreciation. The IRS has made this mandatory because:

1. It creates consistent, predictable expense allocation throughout the asset’s useful life
2. It lines up with the Modified Accelerated Cost Recovery System (MACRS) for residential rental property
3. Calculations and record-keeping are simpler compared to other depreciation methods

The IRS uses specific conventions for real estate depreciation. The mid-month convention assumes you placed your property in service mid-month, which affects your first year’s depreciation amount.

The straight-line depreciation creates equal annual deductions. Note that these deductions lower your property’s tax basis. This will impact your capital gains calculations and potential depreciation recapture once you sell the property.

You can discover the full potential of your real estate investments while staying compliant with IRS regulations by becoming skilled at the straight-line depreciation method.

MACRS and Real Estate Depreciation

The Modified Accelerated Cost Recovery System (MACRS) is the foundation of tax depreciation for real estate investors in the United States. The Tax Reform Act of 1986 introduced this system that determines how you recover investment costs through annual deductions. Your overall tax strategy depends heavily on these deductions.

What is MACRS depreciation

The IRS requires MACRS as the standard depreciation method for property put to use after 1986. This method helps you recover the capitalized cost of your investment property over time through annual tax deductions. The key benefit: MACRS gives you a well-laid-out framework that standardizes depreciation for various real estate assets.

MACRS assigns your property to specific asset classes. These classes determine its recovery period—the time you’ll take to depreciate the asset. Real estate investors deal with two main categories:

• Residential rental property: 27.5-year recovery period
• Commercial property: 39-year recovery period

MACRS vs. straight-line

MACRS might seem complex, but residential and commercial real estate must use straight-line depreciation within the MACRS framework. Your deductions remain equal throughout the asset’s recovery period, unlike the accelerated deductions allowed for other asset types.

MACRS comes with two distinct systems:

1. General Depreciation System (GDS): Most property owners automatically use this standard method unless they choose otherwise. GDS sets a 27.5-year recovery period with straight-line depreciation for residential rental properties.
2. Alternative Depreciation System (ADS): This system extends the useful life to 30 years for residential rental properties, also using the straight-line method. Some situations make ADS preferable or mandatory, especially when properties are used mainly outside the U.S., have tax-exempt use, or are financed with tax-exempt bonds.

IRS rules for real estate assets

The IRS provides clear guidelines about MACRS depreciation for real estate assets. Different property components follow different rules:

• Building structures follow the standard recovery periods (27.5 or 39 years)
• Land improvements depreciate over 15 years using 150% declining balance method
• Some personal property within real estate (like appliances or specialized HVAC) might qualify for shorter recovery periods—usually 5 or 7 years with 200% declining balance method

The “mid-month convention” applies to real estate. Your property’s service start date is considered the middle of the month, whatever the actual date. This affects your first-year depreciation calculations.

MACRS depreciation stops when you recover your original cost basis completely or sell the asset—whichever comes first.

The 27.5-Year Rule for Residential Property

Real estate investors who own residential properties enjoy one of the tax code’s best perks—the 27.5-year depreciation period. This rule helps you save money on taxes throughout your property ownership.

What the 27.5-year rule means

The 27.5-year rule sets the recovery timeline for residential rental properties under the General Depreciation System (GDS). You can deduct your property’s depreciable basis evenly over 27.5 years. This creates bigger yearly deductions compared to commercial properties that use a 39-year period.

Your property must generate rental income from dwelling units to qualify for this faster timeline. Tenants should stay longer than 30 days. Properties with shorter stays, like vacation rentals, might fall under nonresidential classification and face the longer 39-year depreciation period.

The IRS created this shorter recovery period because residential properties wear down faster than commercial buildings. This timing gives you a valuable tax advantage—you can deduct about 3.636% of your property’s depreciable basis each year.

Depreciation schedule for residential rentals

Depreciation starts as soon as your property becomes ready for rent, not on the day you buy it. The GDS method uses a mid-month convention, which means your property’s service date starts at the middle of the month.

You’ll get prorated depreciation in the first year based on this mid-month rule. A property ready for rent on March 15 would receive 9.5 months of depreciation that year—about 2.879% of the cost basis. Each following year brings the full percentage until the final year, which gets prorated too.

Common investor mistakes

Many seasoned investors make these costly mistakes with the 27.5-year rule:

• Failing to separate land value from the building’s cost basis. The IRS won’t let you depreciate land, so including it wrongly in your calculations could trigger an audit.
• Missing depreciation opportunities by not calculating from when the property became rent-ready.
• Neglecting cost segregation studies that speed up depreciation. Without these studies, you treat items like carpets and appliances as building foundations, leaving thousands in tax benefits on the table.
• Forgetting to claim depreciation. The IRS assumes you took depreciation regardless—creating a “phantom tax” through depreciation recapture when you sell.

The 39-Year Rule for Commercial Property

Commercial property depreciation follows a unique timeline that shapes your investment returns over time. The IRS requires a 39-year straight-line depreciation schedule for non-residential real property. This creates different tax implications compared to residential investments.

How commercial property is depreciated

Commercial real estate belongs to the non-residential real property classification within the Modified Accelerated Cost Recovery System (MACRS). This system needs a 39-year recovery period with the straight-line method. The IRS labels properties like office buildings, retail spaces, warehouses, and motels as commercial property, whatever their rental nature.

Your annual depreciation expense calculation for commercial property needs two steps:

1. Determine your property’s depreciable basis (purchase price minus land value)
2. Divide this basis by 39 years to find your annual deduction

To name just one example, see a $1 million office building where land has $200,000 of the value. Your depreciable basis equals $800,000. This gives you about $20,513 in annual depreciation expense ($800,000 ÷ 39). At a 37% tax rate, you save roughly $7,590 in taxes yearly.

Differences from residential depreciation

The biggest difference between commercial and residential depreciation lies in the recovery period—39 years versus 27.5 years. This creates meaningful financial impacts:

Your annual deductions shrink with commercial properties. A $1 million apartment building (residential) gets more and thus encourages more depreciation deductions at $36,360 yearly. A $1 million motel (commercial) brings in only $25,640.

The total lifetime depreciation stays similar for both property types. You just receive the deductions 42% faster with residential properties.

The property’s classification might change due to usage changes, like an apartment building becoming office space. You must switch to the right depreciation schedule on the first day of that tax year.

Tax planning implications

The extended timeline for commercial depreciation makes smart tax planning crucial. Cost segregation studies offer the quickest way to reclassify parts of your commercial property from the standard 39-year schedule to shorter 5, 7, or 15-year categories.

Detailed engineering analysis might qualify components like specialized electrical systems or certain plumbing installations for faster depreciation. The sort of thing I love is that bathroom plumbing in a commercial building usually depreciates over 39 years. That same installation in a specialized business area might qualify as 5-year property.

Land improvements like parking lots might qualify for 15-year depreciation schedules instead of the building’s 39-year timeline. This smart reclassification can boost your early-year tax benefits without changing prior returns.

Bonus Depreciation and Its Sunset

Bonus depreciation gives real estate investors a faster way to get tax deductions, and the rules keep changing as we get closer to 2026. These changing regulations could really affect your investment strategy and profits.

What is bonus depreciation

Bonus depreciation lets you deduct much—or right now, all—of qualifying property costs in the year you start using them, instead of spreading deductions across many years. This provision works differently from standard depreciation and creates immediate tax benefits. You’ll see better cash flow and can put your capital back to work sooner.

The government introduced bonus depreciation in 2002. The Tax Cuts and Jobs Act (TCJA) of 2017 gave it a big boost by allowing 100% first-year depreciation for qualified property. This applied to properties bought and used after September 27, 2017, and before January 1, 2023. Real estate investors saw faster tax savings, especially when they combined this with cost segregation studies.

2026 phase-out rules

Bonus depreciation now follows a scheduled phase-out pattern that cuts the deduction percentage each year. Here’s the timeline:

• 2023: 80% bonus depreciation
• 2024: 60% bonus depreciation
• 2025: 40% bonus depreciation
• 2026: 20% bonus depreciation
• 2027 and beyond: 0% bonus depreciation

Your property’s service date becomes more crucial as the end date approaches. A property that starts service on December 31, 2024, qualifies for 60% bonus depreciation. Wait until January 1, 2025, and your benefit drops to 40%.

How to use it before it ends

You can make the most of remaining bonus depreciation benefits with these strategic approaches:

Start with a cost segregation study on your properties. This IRS-recognized analysis finds building components that qualify for shorter recovery periods and bonus depreciation. These include appliances, cabinetry, and specialized electrical systems. Proper segregation helps qualify large portions of your building for accelerated write-offs.

Look closely at your fixed assets’ recovery periods. The difference between three-year, five-year, and seven-year property matters more for tax planning as bonus depreciation decreases. You might find overlooked reclassifications that speed up deductions.

Pair bonus depreciation with other strategies like the de minimis safe harbor election. This lets you expense amounts up to $5,000 per invoice or item immediately if you have an applicable financial statement and written capitalization policy.

Section 179 and Real Estate

Tax strategies go beyond standard depreciation methods. Section 179 lets real estate investors write off certain property costs right away instead of spreading them over many years.

What is Section 179

Section 179 of the Internal Revenue Code lets businesses deduct the full purchase price of qualifying equipment and property in the same tax year they start using it. This provision creates immediate tax benefits that boost cash flow for reinvestment, unlike traditional depreciation methods.

The evolution of Section 179 has changed a lot for real estate investors. This deduction wasn’t available for personal property in residential rentals before the Tax Cuts and Jobs Act. The removal of these restrictions in 2018 created new opportunities for tax planning.

Eligible property types

Real estate investors can apply Section 179 to several key categories:

• Tangible personal property within rental units, including kitchen appliances, carpets, and window treatments
• Qualified improvement property with interior upgrades to non-residential buildings
• Specialized building components such as roofs, HVAC systems, fire protection, alarm systems, and security systems for non-residential properties
• Computer software used in property management

The main difference lies between residential and non-residential applications. Personal property inside residential rentals qualifies, but building components like HVAC systems only qualify in commercial properties.

Limits and exclusions for real estate

Recent tax legislation sets the maximum Section 179 deduction at $2.5 million for 2025. The deduction reduces dollar-for-dollar once qualifying purchases go over $4 million.

Section 179 comes with important restrictions:

• Land or land improvements don’t qualify
• Permanent structures like buildings and structural components are excluded
• The deduction can’t create a loss (business income limits apply)
• Business use must exceed 50%
• Property bought from related parties doesn’t qualify

Rental activities must qualify as a business rather than an investment to use Section 179. Your rental operations need “regular, systematic, and continuous” activity.

Improvements vs. Repairs

The difference between capital improvements and repairs is a vital part of maximizing tax benefits in your real estate investments. Your tax return and cash flow will be affected by how you classify these expenses.

Capital improvements vs. maintenance

Property value boosts, extended useful life, or new use adaptations are the foundations of capital improvements. You’ll need to capitalize and depreciate these improvements over time instead of deducting them right away. Here’s what counts:

• Added rooms or decks
• New HVAC system installations
• Replacement of all but one of these building components (roof, windows, etc.)
• Full kitchen or bathroom renovations

Regular repairs and maintenance keep your property running smoothly without adding much value. You can deduct these expenses in the same year. Basic repairs include:

• Interior or exterior painting
• Leaky faucet or broken pipe fixes
• Individual damaged floor tile replacements
• Regular cleaning and upkeep

How each affects depreciation

Tax implications create a basic cash flow timing difference:

Current-year deductions from repairs give you immediate tax benefits that lower your taxable income. Capital improvements need to be added to your property’s cost basis with depreciation spread over time—usually 27.5 years for residential properties.

A leaky roof repair can be deducted right away, but a complete roof replacement must be capitalized and depreciated over decades.

IRS classification rules

The IRS looks at three main criteria to determine if an expense needs capitalization:

1. Betterments – Pre-existing defect fixes, material additions, or capacity, efficiency, or quality increases
2. Restorations – Major component replacements, like-new condition rebuilds, or casualty damage repairs
3. Adaptations – Property modifications that change its original purpose

Safe harbor provisions can help you deduct certain improvements through the Safe Harbor for Small Taxpayers, Routine Maintenance Safe Harbor, and De Minimis Safe Harbor.

Depreciation Recapture on Sale

The IRS will want its share back once you sell a property that benefited from depreciation deductions. You should prepare financially by learning about this unavoidable tax event and ways to reduce what you’ll owe.

What is depreciation recapture

The IRS uses depreciation recapture as a tax provision when you sell a depreciated property above its adjusted basis. This tax rule lets the IRS take back the tax benefits you claimed through depreciation deductions.

Real estate usually goes up in value over time. This creates a mismatch because the IRS only justifies your depreciation deductions if your property actually lost value.

How it affects capital gains

Your total tax bill can jump by a lot when you sell residential rental properties due to depreciation recapture. The IRS taxes all your previous depreciation claims at up to 25%.

Here’s a real example: You buy a rental property for $300,000. You claim $50,000 in depreciation deductions and later sell it for $350,000. Your total gain is $100,000. The IRS will tax $50,000 of that gain at up to 25% – usually more than regular capital gains rates.

Properties with cost segregation studies need extra attention. Components depreciated over 5-15 years might face ordinary income tax rates as high as 37%.

Strategies to minimize tax impact

Smart investors use these methods to handle recapture tax:

1. Use a 1031 exchange to push off capital gains and depreciation recapture taxes by buying another qualifying property.
2. Balance out gains with capital losses from other investments or suspended passive losses.
3. Move into the property as your main home before selling to possibly qualify for the Section 121 exclusion.
4. Plan your estate so heirs get a stepped-up basis at death, which removes depreciation recapture.

Remember, the IRS assumes you took all allowed depreciation whether you actually did or not. Tax planning throughout your investment journey becomes crucial.

Tracking Depreciation with Journal Entries

Good accounting documentation is the foundation of your depreciation strategy. Your journal entries must satisfy IRS requirements and show your real estate portfolio’s financial health clearly.

Depreciation expense journal entry basics

The basic depreciation entry uses two accounts: debit “Depreciation Expense” and credit “Accumulated Depreciation”. This contra-asset account shows up on your balance sheet to reduce the property’s carrying value while the expense goes to your income statement.

Separate accumulated depreciation accounts by asset class instead of individual units for multiple properties. This organization makes your financial reporting simpler while keeping the needed detail.

Best practices for real estate investors

A structured approach helps track depreciation throughout the year:

1. Create detailed depreciation schedules for each property
2. Document purchase prices, improvement costs, and tax filings
3. Employ specialized accounting or property management software to automate record-keeping

Your general ledger balances should match year-end accumulated depreciation totals. This reconciliation will give a precise picture in both your internal records and tax filings.

Common accounting errors to avoid

Some mistakes can put your depreciation strategy at risk:

Your failure to track capital improvements separately from routine maintenance creates inaccurate depreciation schedules. Wrong useful life estimates can change tax obligations and distort profitability.

Underestimating depreciation makes property book values too high, which leads to incorrect financial reporting and missed deductions.

Carrying Forward Unused Depreciation Losses

Smart real estate investors know how to get future advantages from suspended losses, even though tax rules restrict immediate depreciation benefits.

When depreciation losses are suspended

Your depreciation deductions might exceed your rental property income, which triggers passive activity loss rules. These passive losses become “suspended” if your modified adjusted gross income (MAGI) goes above $150,000. You can’t take deductions in the current year at this threshold, but the IRS lets you keep these benefits to use later.

How to carry forward losses

The good news is that suspended passive losses never expire—you can carry them forward indefinitely until you use them. You should keep detailed records each year that show:

• The original loss amount
• Which property generated each loss
• Running totals of unused losses

These suspended losses build up on your tax returns and become valuable tax assets over time.

Using losses in future tax years

You can unlock suspended losses through three strategic approaches:

The sale of the property that created the losses releases those specific suspended amounts right away. Better yet, you can apply suspended losses from your entire portfolio—not just the sold property—if you sell any investment property with a gain.

You can offset previously suspended losses by generating enough passive income in future years.

Qualifying as a real estate professional lets you bypass passive loss limitations completely, which might allow you to use previously suspended losses right away.

Conclusion

Real estate investors consider depreciation rules one of their most powerful tax strategies. This piece explains how depreciation affects your bottom line. These principles are the foundations of tax-efficient investing – from using depreciation as a valuable non-cash expense to becoming skilled at the differences between 27.5-year residential and 39-year commercial property timelines.

Of course, you need to pay attention to bonus depreciation’s scheduled phase-out through 2026. You could boost your tax benefits by timing your property acquisitions and improvements before these advantages fade away. On top of that, your decision to classify expenses as repairs or capital improvements affects your immediate cash flow and long-term tax position.

Good record-keeping with detailed depreciation journal entries will give a clear picture of your financial reporting. You can utilize suspended losses for future tax advantages, especially when your income goes beyond the passive activity threshold.

Depreciation offers big benefits while you own the property, but you should prepare for eventual recapture when selling. You can minimize this tax effect through 1031 exchanges or other methods.

These depreciation rules can turn an ordinary real estate portfolio into a tax-optimized investment machine. Now is the time to apply these strategies, before important provisions end in 2026. These depreciation principles give you real advantages throughout your ownership cycle, whether you own residential rentals or commercial properties.

Smart investors put as much effort into tax strategy as they do into choosing properties. Keeping more of what you earn works better than chasing slightly higher returns. The real question is – are you getting the most from these depreciation benefits in your real estate portfolio?