Depreciating the Building, Not the Land
For tax purposes, owners can deduct a portion of a commercial property's cost each year as depreciation, reflecting the idea that a building wears out over time even as its market value may be rising. Land is excluded entirely, because it is not considered to have a determinable useful life. When a property is purchased, the total price is allocated between land and building, often using an assessor's allocation or an appraisal, and only the building portion becomes the depreciable basis.
Under current federal tax rules, commercial (nonresidential) buildings are depreciated on a straight-line basis over 39 years, while residential rental property, including most multifamily, is depreciated over 27.5 years. Straight-line means the same dollar amount is deducted every year over that period, rather than a larger deduction upfront.
The Straight-Line Depreciation Formula
The mechanics are simple once the depreciable basis is established: divide that basis by the applicable recovery period to get the annual deduction. A $10 million office building, after backing out land value, depreciated over 39 years produces roughly $256,000 of depreciation expense per year, taken as a non-cash deduction against the property's taxable income, separate from the deal's actual cash flow.
Cost Segregation: Accelerating the Deduction
A cost segregation study is an engineering-based analysis that reclassifies specific building components, such as certain electrical and plumbing systems tied to equipment, carpeting and finishes, parking lot paving, and landscaping, into much shorter IRS recovery classes, commonly 5, 7, or 15 years instead of 39 or 27.5. Because more of the total cost is depreciated faster, the owner front-loads deductions into the early years of ownership, improving after-tax cash flow when the benefit is often most valuable.
Cost segregation does not create additional total depreciation over the life of the asset; it shifts the timing, pulling deductions earlier. It's most commonly used on larger acquisitions or new construction, where the reclassified basis is large enough to justify the study's cost.
Depreciation Recapture on Sale
Depreciation deductions reduce the property's adjusted basis each year, which increases the taxable gain when the property is eventually sold, since gain is measured against adjusted basis rather than original purchase price. The portion of gain attributable to depreciation already claimed is subject to depreciation recapture, generally taxed differently, and often at a higher rate, than the remaining gain. This is a key reason depreciation and cost segregation decisions should be viewed over the full hold-and-sale horizon, not just the deduction they produce today.
What Cost Segregation Typically Reclassifies
- Certain electrical and plumbing components tied to specific equipment or fixtures
- Carpeting, some flooring, and other interior finishes
- Parking lots, sidewalks, and other site or land improvements
- Specialty equipment or built-in fixtures unique to the property's use
- Signage and certain exterior improvements
Straight-Line Depreciation
Annual Depreciation = (Total Cost Basis − Land Value) ÷ Useful Life (years)
- Total Cost Basis
- — Purchase price plus qualifying capitalized costs ($)
- Land Value
- — Portion of the purchase price allocated to land, which is non-depreciable ($)
- Useful Life
- — IRS recovery period: 39 years for nonresidential property, 27.5 years for residential rental property (years)
Take what you paid for the building, excluding land, and spread it evenly as a tax deduction across its IRS-assigned useful life.
Worked example: A multifamily property is purchased for $8,000,000, with $1,500,000 allocated to land. The depreciable basis is $6,500,000. Divided over the 27.5-year residential recovery period, annual straight-line depreciation is approximately $236,364 per year.
Illustrative MACRS Recovery Periods
| Recovery Period | Example Components | Typical Application |
|---|---|---|
| 5 or 7 years | Certain equipment, carpeting, decorative millwork, some fixtures | Components identified in a cost segregation study |
| 15 years | Parking lots, sidewalks, landscaping, other land improvements | Site improvements identified in a cost segregation study |
| 27.5 years | The building structure itself | Residential rental property, including most multifamily |
| 39 years | The building structure itself | Nonresidential (commercial) real property |
General Education, Not Tax Advice
This content explains general depreciation and cost segregation concepts for educational purposes only and is not tax advice. Depreciable basis, useful life, cost segregation eligibility, and recapture rules depend on the specific asset, its use, and current tax law. Consult a qualified CPA or tax attorney before making any depreciation-related decision on an actual property.
Module Check
Why is land excluded from depreciation deductions on a commercial property?