Definition
Depreciable basis is the portion of a property's total cost that can be depreciated for tax purposes. In real estate, this generally includes the value of the building and certain improvements, but excludes land value, since land is not depreciable.
How It Is Calculated
The starting point is typically the purchase price plus certain acquisition costs, allocated between land and improvements.
Basic formula
- Total Cost Basis = Purchase Price + Capitalized Closing Costs
- Depreciable Basis = Total Cost Basis – Allocated Land Value
Land allocation may be determined using appraisal data, tax assessments, or a reasonable allocation method supported by documentation.
Depreciation Periods
- Residential rental property: 27.5 years (U.S.)
- Commercial property: 39 years (U.S.)
- Personal property components: shorter lives if identified through cost segregation
Example
An investor purchases an apartment building for $5,000,000. An appraisal allocates $1,000,000 to land and $4,000,000 to improvements.
- Depreciable Basis = $4,000,000
- Annual Depreciation (27.5-year schedule) ≈ $145,455/year
Adjustments to Depreciable Basis
- Capital improvements increase basis.
- Casualty losses may reduce basis.
- Cost segregation studies may reclassify portions into shorter recovery periods.
- Bonus depreciation rules may accelerate certain components.
Why It Matters to Investors
- Reduces taxable income without affecting cash flow.
- Improves after-tax returns.
- Impacts gain calculation and potential depreciation recapture at sale.
- Influences underwriting in tax-sensitive investment structures.
Common Pitfalls
- Over-allocating to land, reducing depreciation benefits.
- Failing to capitalize improvements properly.
- Ignoring depreciation recapture when modeling exit proceeds.
- Improper cost segregation assumptions without professional guidance.