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.
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.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.