Depreciation for Real Estate Investors: A Pillar Hub

Frequently asked questions

How does MACRS depreciation work for rental real estate?

MACRS (the Modified Accelerated Cost Recovery System) requires straight-line depreciation over 27.5 years for residential rental property and 39 years for nonresidential real property. Land is not depreciable. A cost segregation study reclassifies qualifying components into 5-year, 7-year, and 15-year recovery periods that use the 200% declining balance method until it crosses over to straight-line.

What is the difference between 27.5-year and 39-year depreciation?

The 27.5-year recovery period applies to residential rental property where 80% or more of gross rental income comes from dwelling units. The 39-year recovery period applies to nonresidential real property including office, retail, industrial, hotel, and self-storage. Both use straight-line depreciation under Section 168 with the mid-month convention in the year placed in service.

What is Section 168 of the Internal Revenue Code?

Section 168 of the Internal Revenue Code is the accelerated cost recovery statute. Section 168(a) prescribes MACRS. Section 168(e) assigns class lives (5, 7, 15, 27.5, and 39 years). Section 168(k) authorizes bonus depreciation, which was restored to permanent 100% by OBBBA (Public Law 119-21) for property acquired and placed in service after January 19, 2025.

What is the difference between Section 1245 and Section 1250 property?

Section 1245 property includes personal property depreciated over 5, 7, or 15 years, such as appliances, carpet, cabinetry, and land improvements. On sale, Section 1245 recapture is taxed at ordinary income rates. Section 1250 property is real property depreciated over 27.5 or 39 years. Unrecaptured Section 1250 gain is capped at a 25% federal rate.

Can I catch up missed depreciation from prior years?

Yes. Form 3115 (Application for Change in Accounting Method) with Designated Change Number 7 captures missed depreciation from all prior years in one tax year. The Section 481(a) adjustment posts in the year of change without amending returns. Rev. Proc. 2022-14 governs the automatic consent procedure. WeCostSeg includes Form 3115 prep with every look-back study.

How does bonus depreciation interact with MACRS recovery periods?

Bonus depreciation under Section 168(k) applies to MACRS property with a recovery period of 20 years or less. That includes 5-year, 7-year, and 15-year property from a cost segregation study. It does not apply to 27.5-year residential or 39-year nonresidential real property. OBBBA restored permanent 100% bonus for post-January-19-2025 acquisitions.

What is Qualified Improvement Property?

Qualified Improvement Property (QIP) is any interior improvement to nonresidential real property placed in service after the building was first placed in service. QIP has a 15-year recovery period under Section 168(e)(3)(E)(vii), added by the CARES Act technical correction. QIP qualifies for 100% bonus depreciation under OBBBA when placed in service after January 19, 2025.

How does depreciation recapture affect the sale of a property?

On sale, Section 1245 recapture on 5, 7, and 15-year property is taxed at ordinary income rates up to 37% federal. Unrecaptured Section 1250 gain on real property is capped at a 25% federal rate. The Net Investment Income Tax adds 3.8% for taxpayers above the threshold. A Section 1031 like-kind exchange defers all of it, with basis carrying to the replacement property.