Commercial Real Estate Depreciation

Under MACRS, nonresidential real property, which is IRS-speak for commercial buildings, has a 39-year recovery period, uses the straight line method, and applies the mid-month convention. No acceleration, no front-loading, the same flat deduction every full year for nearly four decades. Residential rental property gets a shorter 27.5-year schedule under the same method.

The commercial vs residential line is drawn by an income test, not by zoning. A building is residential rental property only if 80 percent or more of its gross rental income for the year comes from dwelling units. A mixed-use building with ground-floor retail and apartments above can land on either schedule depending on where the rent actually comes from, which is worth checking before the first return gets filed, not after year five.

And the rule everyone knows but the numbers still get wrong: land never depreciates, because it does not wear out, become obsolete, or get used up. Every commercial purchase price has to be split between nondepreciable land and depreciable building before the schedule starts. How that split gets set is the first place real dollars move, and it is covered in the next section.

Step one: the clock starts at placed in service, not at closing. Property is placed in service when it is ready and available for its intended use, which for a rental building generally means ready and available to lease, even if no tenant has moved in yet. Buy a building in March and spend four months on the renovation, and depreciation does not start until the space is actually rentable.

Step two: split the purchase price between land and building. The standard is relative fair market value, and the IRS requires a reasonable method rather than one specific formula. The two workhorse methods:

• The assessor ratio. Pull the county assessment card, take the land-to-total ratio the assessor used, and apply that percentage to your actual purchase price. Cheap, documented, and defensible for most straightforward purchases.
• An appraisal. A professional appraisal that separately values the land is stronger evidence, and it matters when the assessor's ratio over-allocates to land or when the numbers are big enough that a few percentage points of allocation are worth real money.

Step three: the mid-month convention prorates year one. Whatever month the building is placed in service, the IRS treats it as placed in service at the midpoint of that month, so you get half of that month plus all the remaining months of the year. Here is what that does to the first-year deduction on a $2,000,000 depreciable basis, straight from the IRS rate table.

The 39-year schedule applies to the building shell and its structural components. But a commercial property also contains land improvements, personal property, and possibly qualified improvement property, each with its own shorter recovery period.

Qualified improvement property (QIP) deserves its own paragraph because it is the most commonly missed bucket on commercial returns. QIP is any improvement you make to the interior of an existing nonresidential building, placed in service after the building itself was first placed in service. Three things are excluded: enlargements of the building, elevators and escalators, and the internal structural framework. Pass the test and the improvement gets a 15-year life and full bonus eligibility instead of riding the 39-year schedule. A $300,000 interior build-out treated as QIP versus 39-year property is the difference between deducting it now and deducting it over four decades.

Separating these buckets on an existing building is exactly what a cost segregation study does: an engineering-based analysis that identifies and prices each component so the reclassification holds up under the IRS's own audit guide. Most commercial studies move roughly 20 to 35 percent of the depreciable basis into the shorter classes, with plain warehouse and distribution boxes often landing lower and specialized facilities higher. The full mechanics, study costs, and audit-defense details live on our cost segregation strategy page; this page stays focused on the schedule itself.

The One Big Beautiful Bill Act made 100% bonus depreciation permanent for eligible property acquired after January 19, 2025. No more phase-down countdown, no more racing a deadline to place property in service. One timing trap survived: property acquired under a written binding contract signed before January 20, 2025 is treated as acquired on the contract date, which can knock otherwise eligible property out of the 100% rate.

The eligibility line matters for commercial owners: bonus depreciation covers property with a recovery period of 20 years or less, plus qualified improvement property. The 39-year building shell never qualifies. Which is the whole partnership between cost segregation and bonus: the study is what converts a slice of your 39-year building into 5, 7, and 15 year property, and bonus is what lets you deduct that entire slice in year one instead of even the shortened schedule.

For the current-year rules, eligibility tables, and the state conformity wrinkles, see our full bonus depreciation guide.

Two honest footnotes before anyone gets excited. First, this is timing, not free money: after the year-one spike, Path B's remaining annual deduction drops to about $38,460 versus $51,280 on the straight schedule, and lifetime depreciation is identical. The value is the time value of the deferral and what you do with the cash now.

Second, depreciation gets recaptured at sale. The straight-line depreciation on the building comes back as unrecaptured section 1250 gain taxed at a maximum 25 percent rate, and the accelerated deductions on reclassified personal property come back as section 1245 recapture at ordinary income rates. A properly structured 1031 exchange can defer the recapture along with the rest of the gain, which is why cost seg and a long hold or exchange strategy travel together. The full exit math lives on our depreciation recapture page and our 1031 exchange guide.

Leasehold improvements: whoever pays, depreciates. If the landlord funds the build-out, the landlord depreciates it; if the tenant pays, the tenant does, regardless of who holds title to the drywall. And the recovery period follows the MACRS class, not the lease: a tenant with a five-year lease still depreciates a non-QIP improvement over 39 years. The saving grace is that most interior, nonstructural build-outs qualify as QIP, which means 15 years and bonus eligibility instead.

Partial dispositions: the deduction hiding in your dumpster. When you replace a roof or an HVAC system, the old component's remaining undepreciated basis does not have to keep riding the 39-year schedule underneath the new one. A partial disposition election lets you write off the remaining basis of the component you tore out, in the year you tore it out. Owners skip this constantly, and skipping it means depreciating a roof that is in a landfill.

Missed depreciation: Form 3115, not amended returns. If depreciation was never claimed, or claimed on the wrong life, the fix is Form 3115, an automatic change in accounting method. A section 481(a) adjustment lets you deduct all the missed depreciation in a single current year, with no amended returns and no IRS pre-approval. This is also how a cost seg study on a building you have owned for years gets applied: the catch-up deduction arrives all at once.

Cost segregation gets sold as a universal answer. It is not, and the failure cases are predictable:

• A short hold with no 1031 planned. Accelerated deductions on 5, 7, and 15 year property come back as section 1245 recapture at ordinary rates when you sell. Sell in two or three years without an exchange and you may hand back most of the benefit at a higher rate than you saved, minus study fees.
• Low depreciable basis. A study has a real cost, and the benefit scales with the basis being reallocated. On a small building with a modest basis, the math can simply fail to clear the fee.
• An imminent taxable sale. If the building is going on the market next year and a 1031 is not in the plan, accelerating deductions into this year mostly converts 25 percent-capped gain into ordinary-rate recapture on the reclassified assets.
• Losses you cannot use. If the deductions create a passive loss you cannot deduct currently under the passive activity rules, the paper loss just sits suspended, carried forward until you have passive income or dispose of the property. Big deductions only help on the schedule you can actually absorb them.

The quickest way to sort yourself into the yes or no pile is to run your building through our cost seg estimator and then pressure-test the result against your hold period and exit plan. Estimates are illustrative; the decision deserves an actual conversation about your numbers.