If you own or invest in commercial real estate depreciation is one of the most valuable tools available to reduce your taxable income. Unlike residential properties, which depreciate over 27.5 years, commercial properties depreciate over 39 years – a bit longer, but can still offer significant tax savings for long-term investors.
What Is Depreciation in Commercial Real Estate?
Depreciation is an IRS-approved tax deduction that allows real estate investors to recover the cost of a property over time. While commercial buildings naturally appreciate in value, the IRS treats them as assets that wear out over time, allowing investors to deduct a portion of their value each year.
How It Works
The IRS assigns a 39-year depreciation schedule for commercial real estate.
Land does not depreciate, only the building and eligible improvements do.
Depreciation reduces taxable income by allowing investors to deduct a portion of the property’s value each year.
Example of Standard Depreciation Calculation
Let’s say you buy a commercial property for $2 million (excluding land, which is valued at $500,000).
Depreciable Basis = $2,000,000 – $500,000 (land) = $1,500,000
Annual Depreciation Deduction = $1,500,000 ÷ 39 years = $38,462 per year
That means you can reduce your taxable income by $38,462 annually, potentially saving thousands in taxes every year.
Cost Segregation: Accelerating Depreciation for Bigger Deductions
A cost segregation study allows investors to accelerate depreciation by identifying portions of a building that can be depreciated faster (instead of over 39 years).
Personal property (5-7 years): Furniture, fixtures, and certain equipment.
Land improvements (15 years): Landscaping, parking lots, sidewalks.
Building structure (39 years): Walls, roof, foundation.
Example:
Instead of waiting 39 years to depreciate everything, a cost segregation study might allow you to write off 20-30% of your property value within the first 5-15 years, significantly reducing your taxable income.
Bonus Depreciation & Section 179 Expensing
With bonus depreciation, investors can immediately deduct 40% (in 2025) of eligible assets rather than depreciating them over time.
Applies to property with a depreciable life of 20 years or less, such as personal property and land improvements identified through cost segregation studies.
Applies to qualified improvements, such as HVAC systems, security systems, and interior upgrades.
Phase-out schedule: The bonus depreciation percentage is gradually decreasing each year until it expires in 2027.
Section 179 Expensing allows investors to write off specific business-related purchases in the first year instead of depreciating them over time.
1031 Exchange: Deferring Taxes on Depreciated Properties
When selling a commercial property, depreciation lowers your cost basis, which increases your taxable gain. However, a 1031 exchange allows you to defer capital gains and depreciation recapture taxes by reinvesting in a new commercial property.
Example:
You purchase a property for $1M and take $300K in depreciation over time.
When you sell it for $1.5M, your taxable gain isn’t just $500K—it’s $800K ($500K + $300K depreciation recapture).
With a 1031 exchange, you can defer all taxes by rolling proceeds into another property of equal or greater value.