Depreciation lets you deduct the cost of a rental building - not the land under it - over 27.5 years, without writing a new check for that deduction each year. When you house hack, you depreciate only the part of the property you rent out, and for many owners that deduction is why the rental side shows little or no taxable income on paper. The tradeoff comes later: depreciation is recaptured when you sell, and paper losses have limits along the way.
Depreciation is one of the most powerful tools a real estate investor has, and one of the least understood. Here it is in plain English, including the one twist that changes the math for house hackers.
The IRS describes depreciation as an annual deduction that lets you recover the cost of certain property over the time you use it - an allowance for wear and tear, deterioration or obsolescence.
Most rental expenses cost you money in the year you deduct them. Depreciation does not. You paid for the building when you bought it, and depreciation spreads that cost across your returns for years afterward. It offsets rental income without any new money leaving your account, which is why it can put more money back in your pocket.
For residential rental property, the IRS uses the straight-line method over a recovery period of 27.5 years. Depreciation begins when the property is ready and available for rent, and the first year is prorated under the mid-month convention.
You can't depreciate land, because in the IRS's words it doesn't wear out, become obsolete or get used up. So the first step is dividing your purchase price between the land and the building.
IRS Publication 527 says to allocate the cost based on the fair market value of each at the time you buy. If you aren't certain of those values, you can divide the cost using the assessed values for real estate tax purposes - and in Iowa, the local assessor establishes that valuation. Your basis generally also includes certain settlement fees and closing costs; your CPA will confirm which ones.
When you rent part of your property, Publication 527 says you divide certain expenses between the rental part and the personal part "as though you actually had two separate pieces of property." You deduct depreciation on the part used for rental, plus that part's share of shared costs like mortgage interest and real estate taxes.
Publication 527's own example is the classic house hack: a duplex where you live in one unit and rent out the other. When the units are about the same size, half of the shared expenses go on Schedule E as rental expenses. If you rent rooms or a lower level in a single-family home, the two most common ways to divide are by number of rooms and by square footage. Costs that belong only to the rented space, like painting the room you rent, are entirely a rental expense.
This example is illustrative only. Every number is hypothetical and does not come from a real property or tax return.
Say you buy a side-by-side duplex in Des Moines for $300,000, and the allocation puts $25,000 on the land and $275,000 on the building. If you rented both units, a full year of depreciation would be $275,000 divided by 27.5, or $10,000.
But you live in one unit and rent the other, and both units are the same size. Your depreciable share is half the building, $137,500. Divided by 27.5, that is $5,000 per full year.
Now say the rented unit brings in $1,100 a month, or $13,200 for the year, and its half of the mortgage interest, property taxes, insurance and repairs comes to $8,200. That leaves $5,000 of net rental income. Subtract the $5,000 depreciation deduction and the rental side reports $0 of taxable income for the year, even though your tenant paid you every month. Yes, you heard that right.
One distinction keeps this honest: the IRS does not let you deduct your mortgage principal payments. Taxable income and cash flow are two different numbers, and I recommend running both before you buy.
If depreciation and expenses add up to more than your rent, the rental shows a loss. Whether that loss can offset your paycheck is governed by the passive activity rules in IRS Publication 925.
If the landlord side is new to you, start with Iowa landlord basics.
Depreciation is not a free pass forever. When you sell, the part of your long-term gain on real property that is due to depreciation is called unrecaptured section 1250 gain, and the IRS taxes that portion at no more than 25%.
Two points matter for house hackers. First, skipping depreciation does not dodge it. The IRS requires you to reduce your basis by the full depreciation you could have deducted, even if you never claimed it, which raises your taxable gain at sale. That is why I recommend claiming it correctly every year.
Second, the home-sale exclusion has limits on a house hack. IRS Publication 523 names "a duplex in which you lived in one unit and rented the other" as a property with a separate rental portion. You generally can't exclude gain on that rented part unless you owned and lived in it for at least 2 of the 5 years before the sale, and you can't exclude gain equal to depreciation allowed or allowable after May 6, 1997.
Keep the time value of money in view, too: the tax savings arrive every year you own the property, while recapture comes years later. And a sale is not the only exit. When you exchange investment real estate for like-kind property under section 1031, you generally are not required to recognize the gain. The full exit picture is in what Central Iowa investors need to know before selling a rental.
What this means for your strategy: depreciation belongs in how you evaluate a house hack from day one, not something you discover at tax time. The land and building split, the share you rent and your income all change what the deduction is worth to you, and recapture belongs in your long-term plan before you buy. I recommend keeping clean records from closing day forward and bringing a CPA in before your first return as a landlord, not after.
The Deal Calculator shows cash flow and break-even, plus a 10-year tax deduction summary and a depreciation recapture line at sale. My 10, 20 and 30-year house hacking math leaves depreciation out on purpose to keep the core math clear, so treat it as one more layer on top. If you are earlier in the process, how to start real estate investing in Central Iowa lays out the first steps.
For the strategy side, the house hacking playbook is the place to start. And if you want a second set of eyes on a specific duplex in the Ankeny-to-Ames corridor or the Des Moines metro, reach out. No pressure - we will run the numbers together.
This is general information, not tax advice - confirm your situation with a CPA before you act.
Payment and rate figures here are illustrative examples, not a quote. What you actually qualify for depends on your credit, the property, and the day you lock. Contact your lender for specifics, or reach out and I can point you to a few reputable local lenders if you are looking for somewhere to start.
Jackson Krile | Flanders Team | RE/MAX Real Estate Center
515.490.8614 · Jackson@FlandersTeam.com
Let's talk through your specific situation - no pressure.