Depreciation is where new preparers lose their footing on a rental. Rent and expenses come straight off the client's records, but depreciation has to be built: the right basis, the right date, the right table. This article walks through a sample tax return with a rental property using the facts from our practice return, showing the method for each piece of Schedule E. The finished numbers are yours to work out when you prepare it as a practice tax return.
The sample tax return: one rental house on Schedule E
The taxpayer is Diane Okonkwo, a single nurse in Fort Worth, Texas. She has a W-2 job and owns one single-family rental house that she manages herself. A leasing agent handles showings and rent collection, but Diane chooses the tenants and approves repairs.
Her 2025 source documents are a W-2, a Form 1098 for the rental mortgage interest, and her own rental records: rent received, property taxes, insurance, and repairs. She bought the house and first rented it out on 03/01/2021 for $300,000, with $52,500 of that price for the land and $247,500 for the building, and depreciation has been taken for 2021 through 2024. Texas has no state income tax, so the return is Form 1040, Schedule 1 and Schedule E.
Step 1: Figure the depreciable basis
Basis starts with the purchase price. Then you add the settlement costs that Publication 527 says belong in basis, including:
- Abstract fees, legal fees and recording fees
- Surveys and transfer taxes
- Title insurance
- Charges for installing utility services
- Amounts the seller owed that the buyer agreed to pay, such as back taxes
Some closing costs never go into basis. Fire insurance premiums, rent for occupying the property before closing, and the costs of getting the loan (points, origination fees) are handled separately.
Next, take the land out. Land does not wear out, so it is never depreciated. When one price covers both, you split it by the fair market value of each part at the time of purchase. If the values are not clear, the IRS lets you use the ratio from the property tax assessment.
Diane's records already split the price. On a real client file, expect to do the split yourself. Here is how it works on a made-up property (not Diane's):
| Illustrative property | Amount |
|---|---|
| Purchase price | $260,000 |
| Title insurance, recording fees, transfer taxes | $4,000 |
| Total cost | $264,000 |
| County assessment: 20% land, 80% building | |
| Building basis ($264,000 x 80%) | $211,200 |
Step 2: Pin down the placed-in-service date
Depreciation starts when the property is ready and available for rent, not when the first tenant moves in. A house that sits ready and listed is in service even while empty.
The month matters: it decides which rates you use for the property's whole life. Diane's house went into service in March 2021.
Step 3: 27.5 years, straight line, mid-month
A building qualifies as residential rental property when 80% or more of its gross rent comes from dwelling units. A single-family rental house fits. Under the General Depreciation System (GDS) of MACRS, it is depreciated:
- Over 27.5 years.
- Straight line, so the yearly deduction is roughly level.
- Using the mid-month convention. The property is treated as placed in service in the middle of its month. A house placed in service in July gets 5.5 months of depreciation in the first year, not 6.
Rental property depreciation example: the table vs. dividing by 27.5
The IRS publishes the rates in Table A-6 of Publication 946 (Table 2-2d in Publication 527). Find the month the property was placed in service and the recovery year, and read the rate where they meet. Part of the table:
| Recovery year | January | March | July | December |
|---|---|---|---|---|
| Year 1 | 3.485% | 2.879% | 1.667% | 0.152% |
| Years 2 through 9 | 3.636% | 3.636% | 3.636% | 3.636% |
| Year 10 | 3.637% | 3.637% | 3.636% | 3.636% |
From year 10 on, the rates alternate between 3.636% and 3.637% until the last partial year.
Back to the made-up building with a $211,200 basis, placed in service in July:
| IRS table | Dividing by 27.5 | |
|---|---|---|
| Year 1 | $211,200 x 1.667% = $3,521 | $211,200 / 27.5 x 5.5/12 = $3,520 |
| Year 2 | $211,200 x 3.636% = $7,679 | $211,200 / 27.5 = $7,680 |
The two methods land within a dollar of each other but rarely match. The reason is rounding. One divided by 27.5 is 3.63636...%, a repeating decimal. The table rounds each rate to three places, so most years drop a sliver and a few years pick it back up. That is why years 10 and later alternate between 3.636% and 3.637%: the rounding is spread out so the rates add up to the full basis over the life of the property. Publication 946 says plainly that figuring MACRS without the tables will generally give a slightly different amount.
Three table rules to remember: apply the rate to the unadjusted basis (the original basis, not reduced by earlier depreciation) every year; once you start using the table for a property, keep using it for the whole recovery period; and if depreciation was skipped in an earlier year, basis is still reduced by the amount that was allowable.
For Diane, use the March row. Count which recovery year 2025 is for a house placed in service in March 2021, read the rate, and apply it to her building basis. That number goes on Schedule E, line 18.
Repairs vs. improvements
A repair keeps the property in ordinary working condition: fixing a broken lock, patching a leak, repainting a room. It is deducted in full on Schedule E, line 14.
An improvement is capitalized and depreciated instead. The test is whether the cost:
- Betters the property (fixes a defect that existed when you bought it, enlarges it, or increases its capacity or quality),
- Restores it (replaces a substantial structural part, or rebuilds it to like-new condition), or
- Adapts it to a new or different use.
A new roof, a replaced HVAC system or an added bathroom is an improvement. It is depreciated as its own asset from the month it was placed in service, over the same 27.5 years as the building. The tangible property regulations also offer a de minimis safe harbor and a routine maintenance safe harbor; read the IRS page in the sources before relying on either.
Where each expense goes on Schedule E
| Item | Schedule E line |
|---|---|
| Rents received | Line 3 |
| Insurance | Line 9 |
| Management fees | Line 11 |
| Mortgage interest paid to banks (Form 1098) | Line 12 |
| Repairs | Line 14 |
| Property taxes | Line 16 |
| Depreciation | Line 18 |
| Other ordinary and necessary expenses | Line 19 |
| Total expenses | Line 20 |
| Income or (loss) | Line 21 |
| Deductible loss after the passive limits | Line 22 |
The property's address goes on line 1a, its type on line 1b (1 for a single-family residence), and fair rental and personal use days on line 2. When the rental is the only Schedule E item, the total on line 26 flows to Schedule 1, line 5.
Does this return need Form 4562?
Often not. For a rental on Schedule E, Form 4562 is required only when you claim:
- Depreciation on property first placed in service during 2025,
- Depreciation on listed property, such as a vehicle, whatever year it was placed in service, or
- A section 179 deduction, or amortization that began in 2025.
Diane's house went into service in 2021, and her records show no vehicle and nothing new placed in service in 2025, so her depreciation goes straight to line 18 with no Form 4562. Keep the depreciation worksheet in the file anyway. In the first year a residential rental is placed in service, it goes on Form 4562, line 19i, with "MM" for mid-month in the convention column.
The passive activity rules in brief
A rental is generally a passive activity, and a passive loss normally offsets only passive income. Depreciation often turns a cash-positive rental into a paper loss, so these rules matter.
The main exception is the $25,000 special allowance. If the taxpayer actively participated (owned at least 10% and made management decisions such as approving tenants, setting rent terms or approving repairs), up to $25,000 of rental loss can offset wages and other nonpassive income. The test is lighter than material participation. Arranging for others to provide services also counts, so using a leasing agent does not by itself rule it out.
The allowance phases out with modified AGI:
- MAGI of $100,000 or less: the full $25,000 is available.
- Between $100,000 and $150,000: the allowance is 50% of the amount by which $150,000 exceeds MAGI.
- $150,000 or more: no allowance.
Married filing separately halves these figures, and the allowance is gone entirely if the spouses lived together at any time during the year. A disallowed loss is not lost; it carries forward on Form 8582. A taxpayer whose only passive activity is rental real estate with active participation, a loss of $25,000 or less, MAGI of $100,000 or less, and no prior-year unallowed losses or credits does not need to file Form 8582 at all.
Recapture when the property is sold
Every dollar of depreciation lowers the building's basis, which raises the gain on a sale, reported on Form 4797. Because MACRS residential rental property is depreciated straight line, there is no "additional depreciation" to recapture as ordinary income. Instead, the part of the long-term gain that comes from depreciation is unrecaptured section 1250 gain, taxed at a maximum rate of 25%. It is based on depreciation allowed or allowable, so a client who skipped depreciation still pays on it later. One more reason to claim it correctly every year.
Sources
- Publication 527 (2025), Residential Rental Property
- Publication 946 (2025), How To Depreciate Property (Table A-6)
- 2025 Instructions for Schedule E (Form 1040)
- 2025 Schedule E (Form 1040)
- Instructions for Form 4562 (2025)
- Instructions for Form 8582 (2025)
- Publication 544 (2025), Sales and Other Dispositions of Assets
- Topic no. 409, Capital gains and losses
- Tangible property final regulations
Frequently asked questions
How do you depreciate a rental property?
Residential rental buildings are depreciated straight line over 27.5 years, starting when the property is placed in service. Land is never depreciated, so you split the purchase price between land and building first. Depreciation is figured on Form 4562 and flows to Schedule E.
Can I deduct a loss on my rental property?
Rental losses are generally passive. If you actively participate and your income is under the limits, you may deduct up to $25,000 of rental loss against other income; that allowance phases out between $100,000 and $150,000 of modified AGI. Losses you cannot use carry forward to future years.