What is Accelerated Depreciation in Real Estate?

Last Updated: May 16, 2024 by Cameron Smith

Accelerated depreciation in real estate allows for rental property owners to claim larger depreciation in early years rather than deducting the same amount each year. This practice allows rental property owners to lower their taxable income now, but increases it later on.

Real Estate Depreciation as a Tax Deduction

Real estate depreciation is one of the many tax benefits afforded to rental property owners. The IRS has decided that a property’s useful life is 27.5 years for residential property or 39 years for commercial property.

This means that rental property owners deduct 3.64% of the property’s value per year. This is called straight-line depreciation because owners depreciate a fixed amount each year.

The IRS allows only the value of the building itself, not the value of the land, to be depreciated. Over time, land doesn’t wear out and break down, and owners don’t have to spend more money to keep it functional.

What Does Accelerated Depreciation Mean?

Accelerated depreciation allows rental owners to depreciate the value of certain aspects of the rental property over a much shorter timeframe than 27.5 years. However, this does not include the house itself—that must still follow the 27.5-year depreciation timeframe.

For example, the cost of a fence might be able to be depreciated over a 10-year period. The flooring cost might be 7 years, and appliances might be 5 years.

Cost Segregation Study

Rental owners should hire an expert to perform what’s called a cost segregation study. The expert determines the cost and useful life of different aspects of the property. This is especially useful because a new owner usually pays for everything in one payment, so they don’t actually know the cost of the fence or floor.

Larger appliances, such as fridges, stoves, and dishwashers, can also be included in accelerated depreciation. Because of their lower relative costs, many rental owners would rather experience larger per-year tax savings for a few years than small savings for 27.5 years.

What Items Typically Qualify for Accelerated Depreciation?

Items that qualify for accelerated depreciation are typically parts of the rental property with a much shorter useful life. Essentially, these are items that likely need to be replaced in the house more quickly.

The following items often qualify for accelerated depreciation:

• Fences
• Appliances (only larger appliances qualify, such as stove, fridge, dishwasher, and washer/dryer)
• Electrical wiring, outlets, and fixtures
• Furniture (if provided by the owner)
• Flooring, such as carpet or hardwood

You’ll need a cost segregation study to know exactly which ones qualify, what the useful life of each is, and the cost.

How to Calculate Accelerated Depreciation

There are a few different accounting methods for calculating accelerated depreciation and how much you can pay per year.

Double Declining Balance

The double-declining balance method of accelerated depreciation allows for the greatest savings in early years with lower savings in later years.

First, you calculate the useful life of an item. Then, you figure out what percentage of the asset’s value would be depreciated each year using the straight-line method.

For example, if a fence is determined to have a value of $20,000 and an expected life of 10 years, the straight-line method would allow for 10% (or $2,000) to be deducted yearly.

With double-declining, you would double the rate. Instead of 10%, you would raise that to 20%. Rather than paying a set amount each year, you would then recalculate 20% of the remaining value of the asset.

Since taking 20% of an amount each year could go on forever, at some point, you’ll have to switch to the straight-line method. Most accountants switch back to the straight-line method once the double-declining method gives you a lower amount than the straight-line method would.

Note that the chart in year 5 switches to the straight-line method, which results in deducting $2,000 per year in years 5-8 (and just $192 in year 9).

Sum of the Years’ Digits

Another way to accelerate depreciation is to add up the years of a property’s useful life. If a fridge has a useful life of 5 years, you would add up 5+4+3+2+1 to get 15.

Then, in year 1, you would depreciate 5/15 of the cost. Year 2 would be 4/15, and so on.

If your fridge costs $2,000, then the depreciation schedule would look like this:

Unlike double-declining balance, you don’t need to reconfigure the asset’s value each year—you simply pay a fraction of the original amount each year. Some property owners prefer this method as it’s a bit simpler than double-declining.

Bonus Depreciation

Bonus depreciation allows owners of eligible properties to depreciate a much larger amount up front. Properties acquired and rented out between September 2017 and January 2023 can have 100% of the costs depreciated in the first year.

This can greatly benefit owners who want to significantly lower their taxable income in that year rather than smaller benefits for a few years.

However, bonus depreciation is also slowly being phased out. It’s already been lowered to 60% for 2024, and it will be 40% in 2025, 20% in 2026, and then 0% in 2027.

Advantages of Using Accelerated Depreciation

There are a few main reasons that rental owners like to use accelerated depreciation for real estate rather than straight-line depreciation.

Bigger upfront savings

Purchasing a rental property is expensive, but accelerated depreciation allows you to recoup some of your costs come tax time. In fact, it’s even possible to report a loss using accelerated depreciation.

Also, rental properties earn less revenue in the early days, but more as time goes on as the owner is able to raise rent. Accelerated depreciation can help those early days be more profitable, and then you can handle a higher tax bill later on with more revenue.

Another way to look at this is you can choose to have the government hold onto some of your money, or you can have it.

Or, the results of your cost segregation study show that 30% of your property depreciates in 7 years. Over those 7 years, depending on your accounting method, you’d be able to write off $44,402 per year!

Potential lower tax bracket

A major deciding factor between using straight-line or accelerated depreciation is whether it can help get you into a lower tax bracket.

If claiming a bit extra in year 1 can result in a major decrease in the percent of your income you’ll owe for taxes, then it’s an easy decision.

Money for other investments

Many property owners are investment-minded people who want to acquire more assets now rather than later. Accelerated depreciation can result in thousands of extra dollars now (rather than down the road) that can be used for their next investment.

Drawbacks of Using Accelerated Depreciation

The main drawback of using accelerated depreciation is that you’ll get fewer tax deductions later. This usually isn’t a good reason because most people would rather have more money now than more money later.

However, there are a few reasons why straight-line appreciation can actually be a better way to go:

1. You expect marginal profit for several years. If you’re buying a profit where you’re looking at breaking even or only experiencing small cash flow for a while, then you may want to extend the tax deductions from depreciation as long as possible.
2. You’re very close to a lower tax bracket. If you forecast that the straight-line depreciation method can put you into a lower tax bracket each year, that’s another reason to depreciate your expenses over a longer time.
3. The expense of the cost segregation study outweighs the tax benefits. If you have an inexpensive property, paying to have the study done may negate the benefits of accelerated depreciation.
4. You want simpler accounting and taxes. With straight-line depreciation, you depreciate the cost of everything related to the building over 27.5 years. With accelerated depreciation, you have to depreciate different items at different rates and track everything.

Depreciation Recapture

Eventually, depreciation needs to be repaid. This means that when calculating your taxes upon selling the property, you must subtract the depreciation you wrote off from the original selling price.

For example, if you bought the house for $300,000 and you depreciated $100,000 of the value, then the IRS would tax the gain as if the original selling price of the house were $200,000. This would show a larger profit for you and, therefore, more taxable income.

This applies to all depreciation but can be especially punitive if you sell the property in the early years and have taken larger deductions due to accelerated depreciation.