What is Tax Depreciation
Tax depreciation is a deduction that lets you recover the cost of a business asset or rental property over its useful life — spreading that cost as annual deductions that reduce your taxable income even though you're not spending any new money.
Depreciation is a tax deduction that allows individuals and businesses to recover the cost of a qualifying long-term asset — equipment, vehicles, rental property, and other property used in a trade or business — over a period of years, rather than deducting the entire cost in the year of purchase.
The idea is that these assets wear out, become obsolete, or lose value over time. Depreciation lets you match that cost reduction against the income the asset helps produce. Unlike most deductions, depreciation doesn't require a new cash outflow each year — it's a deduction for the gradual "using up" of a previously purchased asset.
What Can Be Depreciated
Property is depreciable if it:
- Is owned by you (not leased)
- Is used in a business or income-producing activity (like a rental property)
- Has a determinable useful life exceeding one year
- Is expected to last more than one year
Not depreciable: land (never wears out), inventory, personal-use property, property placed in service and disposed of in the same year.
MACRS: The Standard Depreciation System
Most business assets use Modified Accelerated Cost Recovery System (MACRS), which assigns each asset class a recovery period:
| Asset Category | Recovery Period |
|---|---|
| Computers, certain equipment | 5 years |
| Office furniture and equipment | 7 years |
| Water transportation property | 10 years |
| Farm property | 15 years |
| Residential rental property | 27.5 years |
| Commercial real estate | 39 years |
Under MACRS, more deduction is front-loaded in the early years (accelerated depreciation), reducing taxable income more in the initial years of ownership.
Rental Property Depreciation: The 27.5-Year Rule
For residential rental property, the IRS requires you to depreciate the building (not the land) over 27.5 years using straight-line depreciation. If you purchased a rental home for $300,000 and the land is worth $60,000, you depreciate the building value of $240,000:
$$\text{Annual Depreciation} = \frac{$240,000}{27.5} = $8,727 \text{ per year}$$
This deduction is significant — it can reduce or eliminate taxable rental income even when you're cash-flow positive. However, when you sell, the IRS "recaptures" depreciation previously taken (up to a 25% rate on the depreciation amount), so it's not a permanent tax elimination.
Section 179 Expensing
Section 179 allows businesses to deduct the full cost of certain qualifying property in the year it's placed in service, rather than depreciating it over years. The 2025 limit is $1,220,000 per year, phasing out dollar-for-dollar above $3,050,000 of total qualifying property. This is commonly used for business equipment, vehicles, and improvements.
Bonus Depreciation
Bonus depreciation is an additional first-year deduction for qualifying property. After being 100% in 2022, it has been phasing down: 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026, before expiring (unless extended by Congress).
Depreciation Recapture
When you sell a depreciated asset, the IRS taxes you on a portion of the gain at a recapture rate:
- For Section 1245 property (equipment, vehicles): recapture is taxed at ordinary income rates
- For Section 1250 property (real estate): unrecaptured Section 1250 gain is taxed at a maximum 25% rate
This means rental property owners who benefit from years of depreciation deductions will face a larger-than-normal tax bill in the year of sale. Many real estate investors defer this through a 1031 exchange.