Commercial Real Estate Depreciation Strategies

What Is Commercial Real Estate Depreciation and Why Does It Matter?

Commercial real estate depreciation is a non-cash tax deduction that allows property owners to recover the cost of their investment over a set period determined by the IRS. In simple terms, the tax code recognizes that buildings lose value over time due to wear and tear, and it lets investors deduct that theoretical loss against their taxable income each year.

Depreciation reduces your taxable income without requiring any actual cash outlay, effectively creating tax savings that boost your real cash flow. For a commercial property purchased at $5 million (excluding land value), standard straight-line depreciation generates approximately $128,205 per year in deductions over the 39-year recovery period.

The impact on your bottom line is substantial. If you are in the 37% federal tax bracket, that $128,205 annual deduction translates to $47,436 in tax savings every single year. Over a 10-year hold period, that totals $474,360 in tax savings from depreciation alone, not counting state tax benefits.

Understanding and maximizing depreciation strategies is essential for any serious commercial real estate investor. The right approach can mean the difference between an average return and an exceptional one. Whether you own a multifamily property, an office building, or a retail center, depreciation planning should be part of your investment strategy from day one.

For investors exploring acquisition loans or considering a refinance, understanding depreciation strategies helps you accurately model after-tax returns and make better investment decisions.

What Are the Standard Depreciation Methods for Commercial Property?

The IRS provides specific recovery periods and methods for depreciating commercial real estate. The two primary categories are straight-line depreciation for the building itself and accelerated depreciation through the Modified Accelerated Cost Recovery System (MACRS) for certain building components and personal property.

Straight-Line Depreciation is the default method for commercial buildings. The IRS assigns a 39-year recovery period for non-residential commercial property and a 27.5-year recovery period for residential rental property (properties where 80% or more of gross rental income comes from dwelling units). Under straight-line, you deduct an equal amount each year.

MACRS (Modified Accelerated Cost Recovery System) applies to building components and personal property associated with the real estate. MACRS allows faster depreciation using declining balance methods, which front-load deductions into earlier years. Common MACRS recovery periods include 5 years for carpeting, appliances, and certain fixtures; 7 years for office furniture and equipment; and 15 years for land improvements like parking lots, sidewalks, and landscaping.

Key Calculation Formulas:

• Straight-line annual deduction: (Cost basis minus land value) divided by recovery period
• 39-year commercial: Approximately 2.564% per year
• 27.5-year residential: Approximately 3.636% per year

For a $3 million commercial building (excluding $700,000 in land value), the annual straight-line deduction is $2,300,000 divided by 39, equaling $58,974 per year. That same property classified as residential rental would generate $2,300,000 divided by 27.5, equaling $83,636 per year.

It is critical to note that land is never depreciable. You must allocate your purchase price between land and improvements, typically using the county tax assessor's allocation or an independent appraisal. Getting this allocation right directly affects your total depreciation deductions.

How Does Component Depreciation Accelerate Your Tax Benefits?

Component depreciation, also known as cost segregation, is a strategy that reclassifies portions of a commercial building from the standard 39-year or 27.5-year recovery period into shorter MACRS categories of 5, 7, or 15 years. This dramatically accelerates depreciation deductions into the early years of ownership.

A professional cost segregation study examines every element of a building and identifies components that qualify for shorter recovery periods under IRS guidelines. Typical reclassifiable items include electrical systems dedicated to specific equipment (5 or 7 years), decorative lighting and millwork (5 or 7 years), floor coverings not permanently attached (5 years), specialized plumbing and HVAC components (5 or 15 years), site improvements like parking lots and landscaping (15 years), and security and fire protection systems (5 or 7 years).

The financial impact of component depreciation is significant. For a $5 million commercial property, a cost segregation study typically reclassifies 15 to 40% of the building cost into shorter-lived categories. Using a conservative 25% reclassification rate on a $4 million depreciable basis (excluding $1 million land value):

• Without cost segregation: $102,564 annual deduction ($4M divided by 39 years)
• With cost segregation: Approximately $250,000 to $350,000 in first-year deductions
• Acceleration benefit: $147,000 to $247,000 in additional first-year deductions

For a deeper analysis of how cost segregation studies work and whether one makes sense for your property, read our comprehensive guide on cost segregation studies for commercial real estate.

The IRS has consistently upheld cost segregation when performed by qualified professionals using proper engineering-based methodologies. The key is working with a reputable cost segregation firm that can defend the study if audited. Contact Clearhouse Lending to learn how our financing solutions pair with cost segregation to maximize your returns.

What Is Section 179 and How Can Commercial Property Owners Use It?

Section 179 of the Internal Revenue Code allows commercial property owners to immediately expense the full cost of qualifying property in the year it is placed in service, rather than depreciating it over multiple years. This provides a powerful front-loaded tax deduction that can dramatically reduce taxable income in the acquisition or improvement year.

For 2026, the Section 179 deduction limit is approximately $1.22 million, with a phase-out threshold beginning at approximately $3.05 million in total qualifying property purchases. These limits are adjusted annually for inflation.

Qualifying Property for Section 179 in Commercial Real Estate:

• Qualified improvement property (QIP): Interior improvements to non-residential buildings, including HVAC, fire protection, alarm and security systems, and roofing
• Tangible personal property: Furniture, fixtures, equipment, and machinery
• Certain building components: Heating, ventilation, and air conditioning systems placed in service after the building was first placed in service

Important Limitations to Understand:

1. Section 179 deductions cannot exceed your total active business income for the year. Any excess carries forward to future years.
2. The property must be used more than 50% for business purposes.
3. Real property (the building structure itself) generally does not qualify, but qualified improvement property does.
4. You must elect Section 179 on your tax return for the year the property is placed in service.

Strategic Application Example: You purchase a $2 million retail property and invest $400,000 in interior renovations including new HVAC ($120,000), interior build-out ($200,000), and a security system ($80,000). Under Section 179, you could potentially deduct the full $400,000 in year one, compared to depreciating it over 39 years ($10,256 per year) under standard straight-line depreciation.

For more on maximizing your deductions, review our guide to tax deductions for commercial real estate.

How Does Bonus Depreciation Work for Commercial Real Estate in 2026?

Bonus depreciation allows commercial property owners to take a large percentage of the depreciation deduction in the first year a qualifying asset is placed in service. Under the Tax Cuts and Jobs Act (TCJA) of 2017, bonus depreciation was set at 100% through 2022 and has been phasing down by 20% each year.

For 2026, the bonus depreciation rate is 20%, meaning you can deduct 20% of the cost of qualifying assets in the first year, with the remaining 80% depreciated over the standard recovery period. This phase-down schedule means timing your purchases and improvements strategically can significantly impact your tax outcomes.

Qualifying Assets for Bonus Depreciation:

• Property with a recovery period of 20 years or less (5, 7, and 15-year MACRS property)
• Qualified improvement property (QIP)
• Used property (since the TCJA, previously only new property qualified)
• Components identified through a cost segregation study

Bonus Depreciation Combined with Cost Segregation Example:

Consider a $6 million commercial property acquisition (depreciable basis of $4.8 million after excluding land). A cost segregation study identifies $1.2 million in 5, 7, and 15-year property. With 20% bonus depreciation in 2026:

• Bonus depreciation on reclassified components: $240,000 (20% of $1.2M)
• Regular first-year depreciation on remaining components: Approximately $55,000
• Standard depreciation on the building: $92,308 ($3.6M divided by 39)
• Total first-year deduction: Approximately $387,308
• Compared to straight-line only: $123,077 ($4.8M divided by 39)

The acceleration provides over $260,000 in additional first-year deductions. At a 37% tax rate, that translates to approximately $97,800 in extra tax savings in year one.

For a complete breakdown of bonus depreciation rules and strategies, see our bonus depreciation guide for commercial real estate.

What Strategies Maximize Depreciation Benefits for Tax Planning?

Maximizing depreciation requires a proactive, multi-layered approach that combines several strategies. The most effective commercial real estate investors integrate depreciation planning into their acquisition, financing, and disposition decisions from the start.

Strategy 1: Conduct a Cost Segregation Study at Acquisition

Commission a cost segregation study immediately after purchasing a commercial property. The study can also be performed on properties you already own through a "look-back" study, which allows you to claim previously missed accelerated depreciation without amending prior returns (using IRS Form 3115, Change in Accounting Method).

Strategy 2: Time Purchases to Maximize First-Year Deductions

Because bonus depreciation is phasing down (40% in 2025, 20% in 2026, 0% in 2027 under current law), accelerating acquisitions and improvements into earlier years captures higher bonus depreciation percentages. A property placed in service in December 2026 receives the same first-year bonus depreciation as one placed in service in January 2026.

Strategy 3: Separate Land Improvements from Building Costs

Ensure your purchase price allocation properly identifies 15-year land improvements (parking lots, sidewalks, fencing, landscaping, outdoor lighting, drainage systems). These qualify for both MACRS and bonus depreciation, providing faster write-offs than the 39-year building category.

Strategy 4: Use Section 179 for Qualifying Improvements

When renovating or improving a property, elect Section 179 for qualifying improvements to immediately expense costs. This is particularly effective for value-add properties where you are making substantial interior improvements after acquisition.

Strategy 5: Leverage 1031 Exchanges with Depreciation Planning

When executing a 1031 exchange, you carry over the depreciation schedule from the relinquished property but can perform a new cost segregation study on the replacement property. This creates opportunities to reclassify and accelerate depreciation on the new asset while deferring gains from the sale.

Strategy 6: Consider Partial Asset Dispositions

When replacing building components (a new roof, HVAC system, or parking lot), you can take a partial disposition deduction for the remaining undepreciated value of the old component, then begin depreciating the new component from scratch. This effectively creates a double benefit: a loss deduction on the old asset and new depreciation on the replacement.

Use our DSCR calculator and commercial mortgage calculator to model how depreciation impacts your after-tax cash flow and debt service coverage ratios.

How Do Depreciation Recapture Rules Affect Your Exit Strategy?

Depreciation recapture is the IRS mechanism for recovering previously claimed depreciation deductions when you sell a property. Understanding recapture rules is essential for planning your exit strategy and calculating true after-tax returns.

When you sell a commercial property for more than its depreciated book value, the IRS requires you to "recapture" the depreciation you claimed. For real property (buildings), this recapture is taxed at a maximum rate of 25% under Section 1250. For personal property components (items depreciated under MACRS 5, 7, and 15-year schedules), recapture may be taxed at ordinary income rates under Section 1245.

Recapture Calculation Example:

You purchased a commercial property for $3 million (depreciable basis of $2.4 million), held it for 10 years, and claimed $615,384 in total depreciation. You sell for $4 million.

• Adjusted basis at sale: $3,000,000 minus $615,384 equals $2,384,616
• Total gain: $4,000,000 minus $2,384,616 equals $1,615,384
• Depreciation recapture (taxed at 25%): $615,384 times 25% equals $153,846
• Capital gain (taxed at 20%): $1,000,000 times 20% equals $200,000
• Total tax on sale: $353,846 (plus potential 3.8% Net Investment Income Tax)

Strategies to Manage Recapture:

1. 1031 Exchange: Defer both capital gains and depreciation recapture by exchanging into a like-kind property. This is the most common strategy for avoiding immediate recapture tax.
2. Installment Sales: Spread the gain (and recapture) over multiple tax years to manage your tax bracket.
3. Opportunity Zone Investments: Reinvest gains into Qualified Opportunity Zones for potential deferral and exclusion benefits.
4. Hold Until Death: Under current law, heirs receive a stepped-up basis, eliminating depreciation recapture entirely.

Planning your depreciation strategy alongside your exit strategy is critical. Contact Clearhouse Lending to discuss how financing structures can support your long-term tax planning goals.

What Common Mistakes Should You Avoid with Depreciation?

Even experienced commercial real estate investors make depreciation errors that cost thousands in missed deductions or create compliance problems. Avoiding these common mistakes ensures you capture every available benefit while staying on the right side of IRS rules.

Mistake 1: Failing to Segregate Costs at Acquisition

Many investors simply depreciate their entire building over 39 years without considering cost segregation. For properties valued above $1 million, a cost segregation study almost always pays for itself many times over through accelerated deductions.

Mistake 2: Incorrect Land Allocation

Overstating land value reduces your depreciable basis and your annual deductions. Use the county assessor's allocation or, better yet, obtain an independent appraisal that properly separates land from improvements. Document your allocation methodology thoroughly.

Mistake 3: Missing Partial Disposition Opportunities

When you replace a roof, HVAC system, or other building component, you can write off the remaining undepreciated cost of the old component. Many investors forget this step and miss a valuable deduction.

Mistake 4: Not Tracking Bonus Depreciation Phase-Down

With bonus depreciation decreasing each year, failing to time acquisitions and improvements strategically leaves money on the table. Coordinate with your tax advisor to plan capital expenditures around the phase-down schedule.

Mistake 5: Ignoring State Tax Implications

Some states do not conform to federal bonus depreciation or Section 179 rules. California, for example, does not allow bonus depreciation. Your depreciation strategy may need state-specific adjustments to optimize total tax savings.

Mistake 6: Poor Record-Keeping

The IRS requires detailed records of your cost basis, improvements, depreciation claimed, and dispositions. Inadequate documentation can result in denied deductions during an audit. Maintain organized files for every property, including purchase closing statements, improvement invoices, cost segregation studies, and annual depreciation schedules.

Frequently Asked Questions About Commercial Real Estate Depreciation?

What is the depreciation rate for commercial property?

Non-residential commercial property is depreciated over 39 years using the straight-line method, producing an annual rate of approximately 2.564%. Residential rental property (where 80% or more of income comes from dwelling units) is depreciated over 27.5 years at approximately 3.636% per year. These rates apply only to the building value, as land is never depreciable.

Can you depreciate a commercial property you are still paying a mortgage on?

Yes. Depreciation is based on your total cost basis in the property, regardless of how much you have paid off. Whether you put 20% down or paid all cash, you depreciate the full building value starting when the property is placed in service.

When should you get a cost segregation study?

A cost segregation study is typically worthwhile for any commercial property with a depreciable basis above $1 million. The ideal time is immediately after acquisition, but look-back studies can be performed on properties you have owned for years. The study usually costs $5,000 to $15,000 and frequently identifies $100,000 or more in accelerated first-year deductions.

Does depreciation affect your ability to get a loan?

Depreciation can actually help your loan eligibility. Lenders calculate Debt Service Coverage Ratio (DSCR) using net operating income, which adds back non-cash expenses like depreciation. Use our DSCR calculator to see how your property's income supports financing. Additionally, higher after-tax cash flow from depreciation benefits strengthens your overall financial position.

What happens to depreciation when you sell a commercial property?

When you sell, the IRS recaptures previously claimed depreciation. Real property recapture is taxed at a maximum 25% rate under Section 1250. You can defer recapture through a 1031 exchange into a like-kind property, or heirs receive a stepped-up basis that eliminates recapture entirely.

Is bonus depreciation still available in 2026?

Yes, but at a reduced rate. Bonus depreciation is 20% in 2026, down from 40% in 2025 and 100% in 2022. It applies to assets with recovery periods of 20 years or less and qualified improvement property. The rate drops to 0% in 2027 unless Congress extends it.

Can you take depreciation on property improvements?

Yes. Capital improvements that extend the useful life of a property or adapt it to a new use are depreciable. Qualified improvement property (interior improvements to non-residential buildings) has a 15-year recovery period and qualifies for bonus depreciation and Section 179 expensing. Routine repairs and maintenance, however, are deducted as current expenses.

How does depreciation work with a 1031 exchange?

In a 1031 exchange, you carry forward your depreciation schedule from the relinquished property to the replacement property for the carryover basis. Any excess basis in the replacement property (boot paid) starts a new depreciation schedule. You can perform a new cost segregation study on the replacement property to reclassify and accelerate depreciation on the new asset.

Sources?

1. IRS Publication 946, "How to Depreciate Property," Internal Revenue Service (2025)
2. IRS Revenue Procedure 2022-17, Cost Segregation Audit Techniques Guide, Internal Revenue Service
3. "Tax Cuts and Jobs Act: Bonus Depreciation Phase-Down Schedule," Joint Committee on Taxation, U.S. Congress
4. AICPA Technical Practice Aid on Cost Segregation Studies, American Institute of CPAs
5. National Association of Real Estate Investment Trusts (NAREIT), "Depreciation and Commercial Real Estate Taxation" (2025)

Ready to optimize your commercial property's depreciation strategy? Contact Clearhouse Lending today to discuss how our financing solutions support tax-efficient investing. Whether you are acquiring a new property with an acquisition loan or exploring a refinance to fund improvements, our team can help you structure deals that maximize both cash flow and tax benefits.