Ultimate Guide to Real Estate Depreciation in 2025

Real estate depreciation is a powerful tax tool for property investors, allowing you to reduce taxable income by accounting for property wear and tear. In 2025, changes to tax laws, including bonus depreciation updates, make it even more critical to understand how to maximize these benefits.

Here’s what you need to know:

1. Depreciation Basics: Residential properties are depreciated over 27.5 years (3.64% annually), and commercial properties over 39 years (2.56% annually). Land is not depreciable.
2. Key Changes in 2025: Bonus depreciation has been reinstated at 100% for qualifying properties placed in service after January 19, 2025, offering significant first-year tax savings.
3. Cost Segregation: This method allows you to accelerate depreciation by reclassifying certain property components into shorter timelines, boosting deductions.
4. IRS Guidelines: Use the General Depreciation System (GDS) for faster deductions or the Alternative Depreciation System (ADS) for longer timelines in specific cases.
5. Mid-Month Convention: Depreciation starts on the 15th of the month, regardless of the purchase date, affecting first-year deductions.

To optimize your strategy, focus on timing acquisitions, leveraging cost segregation, planning renovations, and conducting annual portfolio reviews. Proper documentation and compliance with IRS rules are essential to protect deductions and avoid penalties. These strategies can help improve cash flow, reduce tax liability, and support long-term growth in your real estate investments.

The IRS provides two primary depreciation systems - General Depreciation System (GDS) and Alternative Depreciation System (ADS) - each with distinct rules and timelines. Knowing how these systems work can help you align your tax strategy with your investment goals while staying compliant with federal tax regulations.

The General Depreciation System (GDS) is the go-to method for most real estate investors. It uses the well-known depreciation schedules of 27.5 years for residential properties and 39 years for commercial properties, translating to annual deductions of 3.64% and 2.56%, respectively.

GDS operates under the Modified Accelerated Cost Recovery System (MACRS), which allows for higher depreciation deductions in the earlier years of ownership. This approach can improve cash flow early in the investment's life cycle.

On the other hand, the Alternative Depreciation System (ADS) stretches depreciation timelines significantly - 30 years for residential properties and 40 years for commercial properties. While the annual deductions are smaller, ADS is required in certain situations, such as:

1. Properties primarily used outside the U.S.
2. Assets intended for tax-exempt purposes.
3. When bonus depreciation is not elected.

Some investors opt for ADS to simplify long-term tax planning, especially when holding properties for extended periods. With its straight-line depreciation and longer schedules, ADS provides a steady and predictable approach to deductions. Choosing between GDS and ADS - and understanding how to calculate your depreciable basis - can help you optimize your strategy under updated tax rules for 2025.

The depreciable basis of a property determines the amount you can deduct each year, so getting this calculation right is crucial for maximizing tax benefits. Start by adding up the total acquisition cost, which includes the purchase price and certain closing costs like legal fees and title insurance.

One key step: Exclude the value of the land from your depreciable basis since land doesn’t depreciate. If the purchase agreement doesn’t break out land and building values, you can use the property tax assessment ratio or hire an appraiser. For instance, if you buy a property for $400,000 and 25% of the value is attributed to the land, your depreciable basis would be $300,000.

Capital improvements - like installing a new roof or upgrading the HVAC system - can increase your depreciable basis. However, routine maintenance (e.g., painting or minor plumbing repairs) is treated as an immediate expense and doesn’t add to the basis.

Additionally, certain personal property items within the building, such as appliances, carpeting, or light fixtures, may qualify for shorter depreciation schedules compared to the building’s 27.5-year or 39-year timeline. This can lead to quicker tax benefits for these items.

Timing also plays a significant role in depreciation calculations, which is where the mid-month convention comes into play.

The mid-month convention is a tax rule that simplifies depreciation by assuming all real estate is placed in service on the 15th day of the month, no matter the actual acquisition date. This rule applies to both residential and commercial properties under MACRS and impacts deductions in the first and final years of ownership.

For example, whether you acquire a property on January 3rd or January 28th, the IRS treats it as being placed in service on January 15th. This means you can claim 11.5 months of depreciation for the first year, rather than calculating deductions based on the exact number of days you owned the property.

Here’s how it works in practice: Let’s say you purchase a property with a $200,000 depreciable basis in March. The annual depreciation under GDS would be $7,273. Using the mid-month convention, you’d calculate the deduction for 9.5 months:
$7,273 × (9.5 ÷ 12) ≈ $5,758.

The mid-month convention also applies when you sell or dispose of a property. You can only claim depreciation through the middle of the sale month - whether you sell on June 1st or June 30th, the IRS allows just half a month of depreciation for June.

This approach simplifies record-keeping by removing the need to track exact purchase and sale dates for depreciation purposes. However, timing property acquisitions and sales strategically around these rules can help you maximize deductions, especially when managing multiple properties or planning year-end tax strategies.

The tax rules surrounding real estate depreciation have shifted significantly in 2025, offering new ways for investors to optimize deductions. By understanding these updates and adjusting your approach, you can improve both tax efficiency and cash flow.

The Tax Cuts and Jobs Act (TCJA) initially set bonus depreciation to phase out gradually - 40% in 2025, 20% in 2026, and 0% after that. But on July 4, 2025, the One Big Beautiful Bill Act (P.L. 119-21) made a major change: it permanently reinstated 100% bonus depreciation for qualified property placed in service after January 19, 2025.

Here’s how it works: properties acquired before January 19, 2025, still follow the original TCJA schedule. For example, a property purchased on January 15, 2025, qualifies for only 40% bonus depreciation. On the other hand, a property acquired on January 25, 2025, qualifies for the full 100%. This difference can translate into as much as $120,000 in additional first-year deductions on $200,000 of qualifying expenses.

Cost segregation has become an even more powerful tool for boosting first-year deductions. This strategy involves reclassifying certain components of a property into shorter depreciation periods - 5, 7, or 15 years instead of the standard 27.5 or 39 years. With 100% bonus depreciation back in play, every dollar reclassified into these shorter periods can be fully deducted in the first year.

For most commercial or rental properties, 20% to 30% of the building’s value (excluding land) qualifies as personal property or land improvements eligible for accelerated depreciation. In specific cases, such as car washes, RV parks, or storage units, this percentage can climb to 60% or even 100%. One property owner who followed IRS guidelines during a cost segregation study saved over $300,000 in taxes - and successfully passed an IRS audit. To achieve similar results, detailed documentation like invoices, blueprints, and engineering reports is critical.

Cost segregation isn’t just for new purchases. You can apply it retroactively to properties you already own by filing Form 3115. This allows you to claim missed depreciation from prior years. While conducting the study in the year of acquisition or renovation typically provides the most benefit, the look-back option can still unlock substantial savings.

The One Big Beautiful Bill Act also raised the Section 179 expensing cap to $2.5 million. This permanent change provides clarity for long-term tax planning, especially for businesses with significant equipment or property investments.

State tax rules add another layer of complexity. Some states, like New York, don’t follow federal bonus depreciation rules, making the expanded Section 179 expensing even more valuable in those areas. To get the most out of these changes, it’s important to consider both federal and state tax implications.

Additionally, the legislation retains flexibility for partial asset dispositions. For instance, if you replace building components that were previously segregated, you can write off the remaining basis of the replaced items. Pairing this strategy with a well-planned purchase price allocation at the time of sale can also help reduce depreciation recapture taxes, which are taxed at ordinary income rates.

For domestic production facilities, the Qualified Production Property provisions offer another avenue for depreciation benefits. As with all aspects of depreciation planning, working with a qualified tax professional is essential to ensure compliance and maximize the advantages of these new rules. These updates make timing your acquisitions and renovations more important than ever for effective portfolio management.

By staying aligned with recent regulatory updates, you can take advantage of tax benefits to improve your real estate portfolio’s cash flow. Strategic depreciation planning - through well-timed acquisitions, smart renovations, and regular portfolio reviews - can significantly enhance tax efficiency and overall financial performance.

When it comes to maximizing depreciation benefits, the timing of property purchases is key. Acquiring property earlier in the tax year can lead to larger first-year depreciation deductions, especially when bonus depreciation provisions are in play. This strategy becomes particularly valuable if you’re looking to offset significant taxable income, such as capital gains or a sudden increase in earnings. By closing on an investment property within the same tax year, you may be able to leverage accelerated depreciation to reduce your overall tax burden.

It’s also important to consider the mid-month convention (as previously discussed) when setting closing dates, as it can directly influence your first-year deductions.

Another factor to keep in mind is the difference between residential and commercial properties. Residential properties are depreciated over 27.5 years, while commercial properties follow a 39-year schedule. However, commercial properties often include more components that can be reclassified through cost segregation studies, which can accelerate depreciation and increase tax savings.

Well-planned renovations can unlock additional depreciation opportunities. The key is understanding the difference between repairs and capital improvements. Repairs are generally deductible in the year they occur, while capital improvements must be depreciated over time. However, certain improvements may qualify for accelerated depreciation if identified through a cost segregation study.

For example, upgrading a kitchen or replacing an HVAC system can be classified as capital improvements. In some cases, these upgrades may qualify for accelerated depreciation if they are categorized as personal property rather than part of the building’s structure. Flooring improvements also present opportunities: while standard carpeting might follow the building’s depreciation schedule, specialized installation work or subflooring could qualify for shorter depreciation periods.

Timing these renovations is just as important as the renovations themselves. If you’re planning multiple improvements, bundling them within a single tax year could provide greater depreciation benefits compared to spreading them out over several years. This decision should align with your broader tax strategy, factoring in your income and available deductions.

Conducting regular portfolio reviews is essential for capturing all available depreciation benefits and ensuring compliance with tax laws. An annual review allows you to identify missed deductions, utilize retroactive cost segregation (via Form 3115), and maintain accurate documentation for tax purposes.

State tax rules should also be a part of your review. Not all states align with federal bonus depreciation provisions, so alternative strategies - like Section 179 expensing - may sometimes offer better outcomes. By integrating both federal and state tax considerations, you can optimize your overall tax position.

As your real estate portfolio becomes more complex, professional guidance can make a big difference. Firms like The Elle Group specialize in helping investors navigate depreciation strategies, offering tailored advice and data-driven insights to maximize tax benefits while ensuring compliance.

These regular reviews don’t just help with current tax savings - they also prepare you for future opportunities. For instance, if certain properties are nearing the end of their depreciation cycles or you’ve fully utilized their tax benefits, it might be time to explore strategic sales or reinvestment. Pairing this approach with tools like 1031 exchanges can reset depreciation schedules and set the stage for long-term financial growth.

Once you've optimized your depreciation strategy for tax benefits, staying compliant is crucial to protect those gains. The IRS expects detailed and accurate records to back up every claim. Without proper documentation, you risk penalties or losing deductions. Building a strong compliance system safeguards you during audits and ensures you’re maximizing all available tax advantages.

To support your depreciation claims, the IRS requires specific documentation. Missing or incomplete records could lead to disallowed deductions and penalties. Here’s what you need:

1. Purchase records: Include documents that clearly separate the land (which isn’t depreciable) from the building value [3][4]. This includes purchase agreements, closing statements, appraisals, and - if applicable - cost segregation reports [3].
2. Depreciation schedules: These schedules should detail annual depreciation amounts, accumulated totals, and the remaining basis for each property. Be sure to include the date the property was placed in service, as depreciation begins from that point [3][4].
3. IRS Forms: File Form 4562 (Depreciation and Amortization) annually with your tax return to report depreciation. Additionally, report depreciation on Schedule E to document rental income and expenses [3][2][4].
4. Repairs vs. improvements: Maintain records that clearly separate repair costs (immediately deductible) from capital improvements (which must be capitalized and depreciated). Keep invoices, contracts, and receipts to document the scope of work. For mixed-use properties, your records must also show the portions used for business, investment, and personal purposes [1][2][4].

By keeping these records organized and up-to-date, you’ll be well-prepared if the IRS ever questions your claims.

Adopting strong record-keeping habits is key to staying compliant. Here are some best practices to consider:

1. Organized documentation: Keep detailed records of all expenses and property usage. Clearly distinguish between business/investment use and personal use, especially for properties with mixed purposes [1][2].
2. Expense tracking: Record the amount, date, location, and business purpose of each expense. This level of detail is essential if the IRS challenges your deductions [1].
3. Digital backups: Store your records digitally with secure backups. This ensures your documents remain accessible, even if physical copies are lost or damaged.
4. Annual reviews: Revisit your depreciation calculations each year to ensure they align with IRS guidelines. Use a clear categorization system for expenses and justify each classification when necessary.

These steps not only help you stay compliant but also make managing your portfolio easier.

Maintaining compliance while optimizing depreciation can feel overwhelming, especially as your real estate portfolio grows. That’s where professional support can make a difference. The Elle Group, led by seasoned investor Lien Vuong, offers personalized guidance to help investors navigate these complexities while maximizing tax benefits.

By working with experienced tax professionals, you can avoid common pitfalls and ensure your strategies align with IRS regulations [4]. The Elle Group combines real-world investment experience with a deep understanding of tax laws, offering tailored solutions that align with your financial goals.

Their services go beyond tax filings. They provide data-driven insights for ongoing portfolio management, including guidance on documentation practices, the timing of property improvements, and strategic planning for acquisitions and dispositions. For investors managing multiple properties, The Elle Group’s systematic approach ensures compliance and minimizes the risk of oversights that could attract IRS scrutiny.

The firm’s expertise is especially valuable in complex situations, such as cost segregation studies, mixed-use properties, or properties shifting between personal and investment use. Their detailed reviews and proactive compliance checks help identify potential issues early, allowing you to address them before they escalate.

Depreciation can be a game-changer when it comes to building wealth through real estate. By mastering its intricacies, you can lower your tax liability and expand your portfolio more effectively. A solid understanding of this process sets the stage for a smarter, more efficient tax strategy.

Start by determining your depreciable basis accurately - this means separating the land value from the building value. From there, select the depreciation method that fits your investment. For residential properties, this often means using the standard 27.5-year depreciation schedule, while larger investments may benefit from cost segregation studies. Timing also matters. Thanks to the mid-month convention, you can still claim partial depreciation for properties purchased later in the year.

In 2025, the phase-out of bonus depreciation reduces the size of immediate deductions for qualifying properties. To counter this, consider strategies like cost segregation and well-timed acquisitions. These approaches allow you to accelerate depreciation on components like carpeting, fixtures, or landscaping, improving cash flow through tax savings.

Keeping up with changes in tax laws is essential for maximizing your benefits. What worked last year might not apply today, especially with shifts like the adjustments to bonus depreciation. For instance, evolving rules around Section 199A deductions for pass-through entities underscore the need to revisit your strategy regularly.

Staying informed also ensures you don’t miss out on deductions and that your documentation is audit-ready. This includes knowing when repairs cross the line into improvements or understanding the nuances of mixed-use properties. Regularly reviewing IRS guidelines can help you stay compliant and make the most of your tax strategy.

When it comes to navigating the complexities of depreciation, expert advice can make all the difference. The Elle Group combines data-driven insights with practical experience to help investors maximize opportunities while staying compliant.

Professional guidance is especially valuable in scenarios like cost segregation studies, 1031 exchanges, or when properties shift between personal and investment use. With their expertise, The Elle Group can assist in optimizing acquisition timing, planning improvements, and fine-tuning your long-term investment strategy.

To take advantage of 100% bonus depreciation in 2025, the property needs to meet these requirements:

1. It must be purchased and put into use after January 19, 2025.
2. The property must have a class life of 20 years or less.
3. It has to qualify under the Modified Accelerated Cost Recovery System (MACRS).

This tax incentive can help you recover your investment costs faster, making it a valuable tool for your financial planning. It's a good idea to consult a tax professional to ensure your property qualifies and to make the most of your deductions.

The Alternative Depreciation System (ADS) spreads depreciation over longer recovery periods, which leads to smaller but consistent annual deductions. This method can help maintain steady taxable income and is often required for certain industries or specific tax regulations.

On the other hand, the General Depreciation System (GDS) offers shorter recovery periods and accelerated methods, allowing for larger deductions earlier on. This makes GDS a popular choice for those seeking immediate tax relief. However, while GDS is great for short-term tax savings, ADS might be the better option if you're focused on long-term planning or aiming for more predictable income.

Deciding between ADS and GDS comes down to your financial goals and investment strategy. If you're unsure which approach aligns with your real estate portfolio, consulting professionals like The Elle Group can provide tailored advice to help you make informed decisions and work toward your financial objectives.

Cost segregation studies offer a smart way to reduce your tax bill by speeding up depreciation on specific parts of your real estate property. Essentially, this method lets you assign costs to shorter depreciation timelines, which lowers your taxable income faster and boosts your cash flow. And with the enhanced bonus depreciation rules set for 2025, this approach becomes even more impactful.

To make the most of this strategy, you'll need solid documentation. This includes property appraisals, inspection reports, closing statements, and detailed records of asset classifications. These records are crucial for meeting IRS requirements and proving your deductions, ensuring you can claim the maximum tax benefits while staying compliant.