Peggy L CarltonRental property depreciation gives you a yearly non-cash deduction based on the depreciable basis of an income-producing building. Residential rental buildings are generally depreciated over 27.5 years, while land is not depreciable. Accelerated deductions can reduce federal taxable income, but California does not conform to federal bonus depreciation, and recapture may apply when you sell unless it is deferred through a Section 1031 exchange.
Getting to grips with first-time landlord taxes requires a different financial toolkit from owning and maintaining your home. A primary residence cannot be depreciated; depreciation begins only once the property is placed in service as a rental.
Standard rental property depreciation exists without a study. An engineering-based California cost segregation study can accelerate some deductions by identifying qualifying components with shorter recovery periods. It is generally worth considering for higher-value properties rather than every first rental.
What Rental Property Depreciation Can Do for You
Depreciation recognizes the wear and tear an income-producing building experiences over time. The tax code allows you to deduct the building’s depreciable basis across its assigned recovery period, even when you haven’t paid that amount in cash during the year.
The potential benefit becomes clearer with a larger-property example rather than a typical first rental. Consider a client who acquired a California apartment building in 2019 for $5,025,781, with land valued at $3,050,449. A full engineering-based cost segregation study produced an estimated $340,955 in first-year tax savings and a 90:1 payback ratio.
A study identifies qualifying personal property and land improvements that can use shorter schedules than the building. Your actual benefit depends on the property, tax position and ability to use the deductions.
If you placed the property in service in an earlier tax year, you can still commission a look-back study. The resulting adjustment is generally claimed through Form 3115 as a change in accounting method, with the catch-up deduction taken in the current year rather than through amended returns. You’ll still need reliable records for the original purchase price, land allocation, improvements and placed-in-service date so the study begins with an accurate depreciable basis.
Bonus Depreciation Rules
The bonus depreciation rules under IRC Section 168(k) determine whether qualifying short-life assets receive an accelerated first-year deduction.
The One Big Beautiful Bill Act, P.L. 119-21, made 100% bonus depreciation permanent for qualifying property acquired and placed in service on or after 20 January 2025, reversing the phase-down that had been stepping the rate down through 80%, 60%, 40%, 20% and finally 0%.
California does not conform to federal IRC Section 168(k) bonus depreciation. The first-year deduction is federal only, and your California return requires an add-back and separate depreciation calculation. Ask a CPA to model the federal and California treatment and track the two bases independently.
What Rental Property Depreciation Can’t Do for You
Depreciation cannot guarantee an immediate reduction in every tax bill. Your ability to use a deduction depends on passive activity rules, participation and the income available to offset.
Passive Activity Limits
Accelerated deductions are not automatically usable against other income. Under IRC Section 469, losses from rental activity are generally passive, meaning they suspend and carry forward against future passive income, or release on disposition, rather than offsetting wages or business income in the year they arise. At federal level two exceptions apply. Real Estate Professional status under Section 469(c)(7) requires more than 750 hours annually in real property trades or businesses, more than half of total working time, and material participation. Separately, the short-term rental exception under Reg. 1.469-1T(e)(3)(ii)(A) applies where average guest stay is seven days or less and the owner materially participates. California is the important exception here: the state does not conform to Section 469(c)(7), so real estate professional status does not carry over to a California return even where it is established federally. Material participation requires satisfying one of the seven tests in the regulations – most commonly the 500-hour test, or the test requiring more than 100 hours with no other individual participating more.
Depreciation Recapture
Accelerated depreciation is a timing benefit, not a permanent one, and the reckoning comes at sale. The 5- and 7-year personal property a study reclassifies is Section 1245 property, recaptured at ordinary income rates up to 37%. The 15-year land improvements and the building itself are Section 1250 property, where depreciation claimed in excess of straight line is ordinary income and the straight-line portion becomes unrecaptured Section 1250 gain, capped at 25%. Recapture can be deferred through a Section 1031 exchange. This is why hold period matters: a study generally makes sense on a three-to-five-year minimum hold, and is most compelling at five years or longer.
