Investing in rental properties comes with many financial benefits, but one of the most powerful tools that investors often overlook is depreciation. Unlike expenses such as repairs, property taxes, or insurance, which you deduct in the year they’re paid, depreciation allows you to recover the cost of your property over time. It spreads out the deduction across several years to reflect the natural wear and tear on the building.

At first glance, depreciation might seem like just another IRS calculation, but it can make a dramatic difference in how much tax you owe each year. In fact, for many property owners, depreciation is the factor that turns a rental from a break-even investment into a profitable one after taxes.

But here’s the catch: the IRS places rules and limits on how depreciation interacts with your income. If your rental property produces losses due to large depreciation deductions, you may not always be able to claim those losses depending on how much you earn. That’s where rental property depreciation income limits come into play.

This article will walk you through how depreciation works, how to calculate it, which properties qualify, and what the income restrictions mean for you as an investor. By the end, you’ll have a clear picture of how to use this tax benefit to your advantage.

Understanding Rental Property Depreciation Income Limits

Depreciation is a tax deduction, but it isn’t unlimited. While the IRS allows you to claim depreciation every year on qualifying rental property, your ability to use those deductions depends heavily on your income level.

Here’s why: rental income is considered “passive income” under IRS rules, and losses from passive activities can’t always be deducted against active income, like wages from your job. The IRS has a special allowance that lets many property owners deduct up to $25,000 in rental losses per year, but only if their modified adjusted gross income (MAGI) is below $100,000.

• If your MAGI is $100,000 or less, you can claim the full $25,000 in rental losses.
• Between $100,000 and $150,000, the allowance begins to phase out. For every $2 above $100,000, the deduction is reduced by $1.
• At $150,000 or more, the special allowance is gone, meaning you cannot deduct passive rental losses against your other income unless you qualify as a real estate professional.

This rule is why high-income investors sometimes feel frustrated by depreciation. The deduction exists, but its impact on their taxes is limited. The good news is that any unused depreciation isn’t wasted; it can be carried forward into future years until it’s used or the property is sold.

Understanding the rental property depreciation income limit helps you plan strategically. For example, if your income is near $100,000, delaying certain income or accelerating expenses could allow you to qualify for a larger deduction.

How Does Depreciation Work on a Rental Property?

Depreciation reflects the idea that buildings wear out over time. Even though your property may be gaining market value, the IRS assumes the structure itself is losing value as tenants use it and as years go by.

Here’s how it works:

• The IRS requires residential rental properties to use the Modified Accelerated Cost Recovery System (MACRS).
• Under MACRS, you depreciate the property over 27.5 years. This means each year you can deduct a portion of the property’s value (excluding land).
• The deduction starts the moment the property is ready to rent—not necessarily when it’s occupied.

For example, imagine you purchased a duplex for $300,000. If the land value is $60,000, that leaves $240,000 to depreciate. Divided over 27.5 years, you’d receive about $8,727 in depreciation deductions each year. That’s $8,727 in taxable income you don’t have to pay taxes on annually.

This system creates a powerful incentive for property ownership, especially when combined with other deductions like mortgage interest, repairs, and insurance.

How to Calculate Depreciation on Residential Rental Property

So, let’s dive deeper into how to calculate depreciation on rental property step by step:

1. Establish your cost basis. Start with the purchase price of the property. Include certain closing costs like title insurance, attorney’s fees, and recording fees. Don’t include settlement charges like loan origination fees.
2. Separate land and building value. Land doesn’t depreciate, so you need to assign a percentage of your purchase price to land and the rest to the structure. Local tax assessments often provide this breakdown.
3. Add qualifying improvements. If you make upgrades, such as installing a new roof or remodeling the kitchen, these costs are added to your basis and depreciated over time.
4. Apply the 27.5-year rule. Divide your adjusted building value by 27.5. This gives you the annual deduction.
5. Account for timing. If you put the property into service mid-year, your first-year deduction will be prorated using the IRS “mid-month convention.”

For instance, let’s say you bought a single-family rental for $200,000, with $50,000 allocated to land. Your depreciable basis is $150,000. Divide that by 27.5, and you get about $5,454 per year in depreciation. If you started renting in July, your first-year deduction would be roughly half that amount.

Working with a CPA ensures accuracy, especially if you own multiple properties or make significant improvements that complicate the calculations.

What Residential Rental Property Can Be Depreciated?

Not everything on your property qualifies for depreciation. The IRS sets clear guidelines:

Depreciable items include:

• The rental building itself.
• Additions and improvements, such as new rooms, HVAC systems, or flooring.
• Appliances and furniture used in the rental.
• Structural components like roofs, plumbing, and electrical systems.

Non-depreciable items include:

• Land, since it doesn’t wear out.
• Routine repairs and maintenance (these are deducted in the year they occur).
• Personal use areas of the property, if it’s a mixed-use property (like part rental, part primary residence).

Knowing the difference ensures you claim only what’s allowed while maximizing your deduction potential.

What Rental Properties Benefit Most from Depreciation?

Every rental property benefits from depreciation, but some situations make it especially valuable:

• High-cost properties: Larger, more expensive properties generate bigger depreciation deductions.
• Properties with significant upgrades: Renovations and improvements increase the depreciable basis, raising the annual deduction.
• Long-term rentals: Depreciation works best when you hold the property for many years, allowing you to take advantage of the deduction annually.
• Real estate professionals: If you meet the IRS definition of a real estate professional, income limits don’t restrict you. This means you can offset other income with depreciation deductions even if you earn above $150,000.

For example, a doctor earning $200,000 might not be able to use depreciation fully due to the income limit. But if that doctor qualifies as a real estate professional, say by spending more than 750 hours a year actively managing properties, they could apply depreciation losses against their full income.

Conclusion

Depreciation is one of the most powerful advantages of real estate investing. It lowers your taxable income, preserves cash flow, and gives you a tool to offset other rental expenses. But understanding the rental property depreciation income limit is just as important as knowing how to calculate it. Income restrictions can change the way these deductions impact your taxes, and careful planning is the key to maximizing the benefit.

If you want to go beyond the basics and truly build wealth through real estate, learning from experienced investors is the next step. Dwan Bent-Twyford, founder of Dwanderful, is a seasoned investor and podcast host who teaches both beginners and experienced landlords how to grow their portfolios strategically. On her site, you can grab a free copy of her book Real Estate Lingo to master the terms that every investor should know. For a deeper dive, her book Five Pillars of Real Estate Investing outlines a proven system for building sustainable wealth.

And if you’re curious about your own potential, try her quick quiz game, it takes less than a minute and shows how you could generate six figures in just six months, whether you’re buying your first property or scaling up. By combining smart tax strategies like depreciation with proven investing methods, you’ll set yourself up for long-term financial freedom. Contact us now!

Frequently Asked Questions

Does Depreciation Offset Rental Income?

Yes. Depreciation reduces your taxable rental income by spreading the property’s cost over 27.5 years. In many cases, it can even create a paper loss, lowering your overall tax burden.

Is There an Income Limit for Claiming Rental Property Depreciation?

There’s no limit on calculating depreciation itself, but the ability to deduct passive rental losses is phased out for incomes between $100,000 and $150,000, and eliminated above $150,000 unless you qualify as a real estate professional.

Should I Depreciate My Rental Property?

Yes—you’re required to. Even if you don’t claim depreciation, the IRS assumes you did and will apply “recapture” when you sell, meaning you could face taxes on depreciation you never actually deducted.

How to Report Rental Property Depreciation to the IRS?

You report depreciation using Form 4562, which flows into Schedule E of your tax return. Many landlords use tax software or hire a CPA to ensure accuracy.