Real Estate Tax Calc
Why purchase price isn't your depreciation starting point
Many new landlords assume they can depreciate the full amount they paid for a rental property. That's not how it works. The IRS requires you to exclude the land value from the depreciation calculation — land doesn't wear out, so it isn't depreciable. You can only depreciate the building and improvements.
Additionally, several closing costs must be added to the property's tax basis rather than deducted currently, and some items affect basis differently. The starting number for depreciation — called the depreciable basis — is: purchase price plus capitalized acquisition costs, minus the value allocated to land.
What goes into the depreciable basis
The depreciable basis of a rental property includes: the portion of the purchase price allocated to the building (not land), plus capitalized closing costs such as title insurance, attorney fees, recording fees, and transfer taxes. It does not include the land portion of the purchase price, prepaid property taxes or insurance at closing (separately deductible as operating expenses), or amounts paid for the buyer's personal-use items.
Example: You purchase a rental for $400,000. The county assessment allocates 20% of value to land and 80% to the building. Your land value is $80,000 and your building value is $320,000. You paid $3,000 in capitalized closing costs. Your depreciable basis is $320,000 + $3,000 = $323,000, depreciated over 27.5 years (residential) for an annual deduction of about $11,745.
How the basis changes over time
Basis is not static. It increases when you add capital improvements (a new roof, a kitchen remodel, a garage addition) — these are depreciated separately from the original building, often over the same 27.5-year schedule for a residential rental. Basis decreases as you take annual depreciation deductions (your adjusted basis falls each year).
When you sell, the difference between your sale price and your adjusted basis determines your taxable gain. Low adjusted basis = high taxable gain. This is why keeping records of every improvement — receipts, permits, contractor invoices — matters from day one. A $10,000 kitchen remodel added to basis reduces your eventual capital gain by $10,000.
Allocating land vs. building: the methods ranked
Because land is not depreciable, the land/building split directly controls the size of your deduction — and it is the number the IRS most often challenges. Several methods are accepted, and it is wise to pick the most defensible one for your facts and keep the supporting document. The county tax assessment ratio is the most common: if the assessor values the parcel at $50,000 land and $200,000 improvements, 80% of your purchase price is building. A qualified appraisal that separately values land and improvements is the strongest support and is worth ordering for higher-value properties. Comparable land sales in the area can establish the land value directly, leaving the remainder for the building. An insurance replacement-cost estimate for the structure can corroborate the building figure, since insurance covers the building but not the land.
Whatever you choose, apply it consistently and avoid the temptation to push an aggressive share to the building. An allocation that assigns almost nothing to land in a market where land is plainly valuable is exactly the kind of position an examiner reverses, which claws back deductions and can trigger penalties. Document the method and the source figures in your file the year you place the property in service — reconstructing the allocation years later is far harder.
Which closing costs are capitalized, deducted, or amortized
Not every line on the settlement statement is treated the same way, and sorting them correctly changes both your first-year deduction and your basis. Capitalized into basis (and depreciated with the building): owner's title insurance, title search and abstract fees, recording fees, transfer and documentary stamp taxes, survey costs, and legal fees tied to the purchase. Deducted currently as operating expenses on Schedule E: prepaid property taxes allocable to your ownership period and the rental portion of prepaid hazard insurance. Amortized over the life of the loan rather than added to the property's basis: loan origination fees and points, the lender's required appraisal, credit report fees, mortgage recording tax on the loan, and other costs of obtaining financing — these are recovered as additional interest expense over the mortgage term, and any unamortized balance is deductible in full if you pay the loan off early.
The practical takeaway: a single closing generates three different tax buckets. Getting a copy of the final closing disclosure and coding each line to the right bucket at purchase time saves your preparer from guessing and prevents financing costs from being wrongly buried in the depreciable building basis.
A fuller worked example from the closing statement
Suppose you buy a single-family rental for $400,000. The closing disclosure shows $4,000 of owner's title insurance and recording fees, $2,000 of loan origination points, and $1,800 of prepaid property taxes and insurance. The county assessment splits value 25% land / 75% building.
Start with the $400,000 price. The $4,000 of title and recording costs are capitalized, so total acquisition cost is $404,000. Allocate 25% ($101,000) to land — not depreciable — leaving $303,000 as the depreciable building basis, recovered over 27.5 years for roughly $11,018 per year. The $2,000 of loan points are not added to this basis; they are amortized over the loan term as interest. The $1,800 of prepaid taxes and insurance are currently deductible operating expenses, not basis. Three line items, three destinations — and only the first two touch your depreciation figure.
Basis for gifted, inherited, and converted property
When you did not buy the rental in an ordinary cash purchase, the starting basis rules shift. For gifted property, you generally take a carryover basis equal to the donor's adjusted basis, subject to a dual-basis rule: if the property's fair market value at the date of the gift is below the donor's basis, you use that lower FMV when computing a loss. For inherited property, the basis is generally stepped up (or down) to fair market value on the date of death, which resets depreciation and can erase a prior owner's accumulated depreciation entirely — one reason holding until death is such a powerful planning tool.
A case that trips up many owners is converting a former personal residence into a rental. For depreciation, your basis is the lesser of (a) your adjusted basis in the home or (b) its fair market value on the date you convert it to rental use. If the home has declined in value since you bought it, you must depreciate off the lower FMV, not your higher cost — and you capture the land/building split as of the conversion date. Get a valuation at conversion and keep it, because this figure anchors every year of depreciation that follows.
Cost segregation: splitting the basis for faster deductions
The building basis you compute is not necessarily one monolithic 27.5- or 39-year asset. A cost segregation study engineers the purchase price into its components, reclassifying items like carpeting, cabinetry, appliances, and specialty electrical into 5- and 7-year personal property, and site work like driveways, fencing, and landscaping into 15-year land improvements. Those shorter-life buckets depreciate far faster than the structure and can be eligible for bonus depreciation, front-loading deductions into the early years of ownership.
The trade-off is at sale: the components carved into Section 1245 personal property are recaptured as ordinary income up to the depreciation claimed, rather than as unrecaptured Section 1250 gain capped at 25%. Cost segregation still tends to win on the time value of money, but it makes an accurate, component-level basis schedule essential — you cannot recapture correctly what you never tracked separately.
Adjusted basis, depreciation recapture, and why records matter
Your adjusted basis is the running figure: original depreciable basis, plus capital improvements, minus depreciation claimed (or allowable) each year. It falls steadily as you depreciate, which is precisely why a long-held, well-depreciated rental can generate a large taxable gain even at a modest sale price. At sale, the depreciation you took comes back as unrecaptured Section 1250 gain, taxed at a maximum of 25%, and the rest of the gain is long-term capital gain.
Critically, the IRS taxes recapture on depreciation allowed or allowable — meaning you owe it on what you could have deducted even if you never claimed it. There is no benefit to skipping depreciation, and every reason to keep meticulous records: the original allocation, every improvement receipt, and the annual depreciation schedule are what let you prove your adjusted basis and split the eventual gain correctly. Undocumented improvements become lost basis and, therefore, needlessly taxed gain.
Frequently asked questions
How do I allocate the purchase price between land and building?
Common methods: use the county tax assessment ratio, order an appraisal, or use comparable land sales. The IRS may challenge allocations that seem designed to inflate the building's share.
Can I depreciate a property I bought from a family member?
Yes, but special related-party rules apply. Your depreciable basis is the lesser of your purchase price or the seller's adjusted basis — which can significantly limit your deductions if they had fully depreciated the property.
Do capital improvements get depreciated separately?
Yes. A new roof or HVAC added to a residential rental is depreciated over 27.5 years starting in the year it is placed in service, as a separate asset from the original building.
Are loan points and origination fees added to my depreciable basis?
No. Loan-related costs — points, origination fees, the lender's appraisal, credit report — are amortized over the life of the loan as interest expense, not capitalized into the property's basis. Any unamortized balance is generally deductible in full if you pay off or refinance the loan early.
I converted my old home into a rental. What's my depreciable basis?
The lesser of your adjusted basis in the home or its fair market value on the date of conversion. If the home has fallen in value since you bought it, you must depreciate off the lower FMV. Get a valuation at conversion and keep it, since it anchors every year of depreciation.
If I don't claim depreciation, do I avoid recapture?
No. The IRS taxes recapture on depreciation 'allowed or allowable,' meaning what you could have deducted whether or not you actually claimed it. Skipping depreciation forfeits the deduction without avoiding the recapture, so there is no upside — take it and keep clean records.
Which closing costs can I deduct in the first year?
Prepaid property taxes for your ownership period and the rental share of prepaid insurance are currently deductible. Title insurance, recording fees, transfer taxes, and survey costs are capitalized into basis; financing costs like points are amortized over the loan term.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.