Depreciation is the tax deduction that allows real estate owners to write off the cost of a building, though not the land beneath it, over a set number of years defined by the IRS, reflecting the theoretical decline in the asset's value through use and age. For residential rental property this period runs longer than for commercial property, and the deduction is taken annually regardless of whether the property is actually appreciating in market value, which is one of the more counterintuitive features of real estate taxation.
Because depreciation is a non-cash expense, it can reduce or eliminate an investor's taxable income from a property even while that property generates positive cash flow. Investors who want to accelerate this benefit beyond the standard straight-line schedule often use a cost segregation study to identify components eligible for shorter depreciation periods. When a property is eventually sold, accumulated depreciation is generally subject to recapture, which partially reverses the earlier tax benefit.
Further reading: Inside a Cost Segregation Study: How a Building Becomes a Tax Shield for Its LPs
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