Depreciation is the annual tax deduction that allows an owner to recover the cost or other basis of income-producing property over time. The IRS allows it because buildings and improvements are treated as wasting assets used in a trade or business or for the production of income, even if market value is stable or rising.
For federal tax purposes, depreciation is not based on current appraised value. It is based on tax basis and statutory recovery rules. IRC §168 provides that the depreciation deduction for tangible property is determined using the applicable method, recovery period, and convention.
That is why commercial property depreciation can reduce taxable income without requiring a current cash outlay. The owner may still have positive cash flow while claiming a noncash deduction each year.
IRC §168 classifies nonresidential real property as section 1250 property that is neither residential rental property nor property with a class life under 27.5 years. Its recovery period under General Depreciation System (GDS) is 39 years, and the required method is straight line.
In practice, the Commercial Real Estate Depreciation schedule means the building basis is deducted ratably over 39 years using the mid-month convention. If a building is placed in service in a given month, depreciation begins as though it were placed in service at the midpoint of that month.
Land is never depreciated because it does not wear out, become obsolete, or get used up. Owners must allocate purchase price between nondepreciable land and depreciable improvements.
A cost segregation study identifies portions of a building that are not properly treated as 39-year real property. Depending on the facts, certain assets may instead qualify as 5-, 7-, or 15-year property, such as specialized electrical, plumbing, land improvements, or removable finishes.
That matters because shorter recovery periods accelerate deductions. Instead of waiting 39 years, the owner may recover those components much faster under MACRS and, where eligible, through immediate expensing rules.
For many owners, cost segregation commercial real estate planning is really a timing strategy: it does not create deductions from nothing, but it can move deductions into earlier years when cash flow matters most.
After P.L. 119-21, the rules changed materially. For qualified property acquired after January 19, 2025, IRC §168(k) generally allows 100% bonus depreciation. For property acquired before January 20, 2025, the older phasedown still applies, including 40% for 2025 and 20% for 2026.
Qualified property generally includes MACRS property with a recovery period of 20 years or less, certain software, and water utility property, but not property required to use Alternative Depreciation System (ADS).
For owners evaluating bonus depreciation real estate, acquisition date is now critical because January 20, 2025 is the dividing line between the old phaseout regime and restored full expensing.
When depreciated property is sold, prior depreciation deductions do not simply disappear. The tax law adjusts the character of the gain to account for depreciation previously claimed.
For section 1245 property, gain is generally recaptured as ordinary income up to depreciation allowed or allowable. For section 1250 property, the rules are more nuanced, but depreciation still affects the character of gain.
That means depreciation recapture real estate planning should be part of the acquisition strategy, not just the exit discussion. Owners often focus on current deductions and underestimate the later tax effect when they sell.
A proper model should also help owners Calculate Depreciation Recapture before disposition so sale proceeds, after-tax yield, and structuring alternatives can be evaluated realistically.
Is the depreciation schedule the same for residential and commercial rental properties?
No. Residential rental property is generally depreciated over 27.5 years, while nonresidential real property is generally depreciated over 39 years under GDS. Both use straight-line depreciation, but they are separate statutory categories under IRC §168.
What is a lookback study and when does it make sense to do one?
A lookback study is a cost segregation analysis performed after a property was already placed in service. It can make sense when prior returns used 39-year treatment for everything and the owner wants to accelerate missed deductions through accounting method procedures.
Can I still claim depreciation on a commercial property I am actively renovating?
Yes, but the answer depends on what is already placed in service and what is still under construction. Existing placed-in-service property continues to depreciate, while new improvements generally begin depreciation only when they are ready and available for use.
Does completing a 1031 exchange let me reset or restart depreciation on the replacement property?
Not entirely. In general, carryover basis from relinquished property continues under special rules, while any excess basis may be treated as newly placed-in-service property. The result is often a blended depreciation profile rather than a full restart.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Trey Webb, partner in charge of Bennett Thrasher’s Real Estate and Hospitality Tax Group, or call us at 770.396.2200.
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