Depreciation

Depreciation allows you to deduct the cost of an asset over time rather than all at once. If you buy a rental property building (not land) for $200,000 with a 27.5-year useful life, you can deduct approximately $7,273 per year in depreciation — reducing your taxable income without spending additional money.

For rental property investors, depreciation is one of the most powerful tax benefits. It can create "paper losses" even when the property generates positive cash flow. A rental earning $1,000/month in net cash flow ($12,000/year) with $7,273 in depreciation has taxable income of only $4,727 — or could show a loss when combined with other deductions.

Different asset types have different depreciation schedules: residential rental property (27.5 years), commercial property (39 years), computers and equipment (5 years), vehicles (5 years), and furniture (7 years). Section 179 and bonus depreciation allow faster write-offs — sometimes deducting the entire cost in year one.

Depreciation recapture is the tradeoff. When you sell a depreciated asset, the IRS "recaptures" the depreciation deductions at a 25% rate (for real estate) rather than the lower capital gains rate. If you depreciated $100,000 of a property and then sell, you owe $25,000 in depreciation recapture tax on top of any capital gains tax.

A 1031 exchange can defer depreciation recapture by exchanging into a like-kind property. This is why many real estate investors never sell — they exchange properties, continue depreciating, and defer taxes indefinitely. At death, the heirs receive a stepped-up basis, potentially eliminating the deferred tax entirely.