Depreciation is a tax deduction that allows rental property owners to deduct a portion of the property's building value (not the land, since land isn't considered a depreciating asset) each year over a set recovery period, currently 27.5 years for residential rental property under IRS rules. This deduction reduces taxable rental income, often making a property that shows positive cash flow appear to have a loss for tax purposes, which is one of the more significant tax advantages of owning rental real estate. The calculation starts with determining the building's depreciable basis, which is generally the purchase price allocated to the structure (excluding land value), plus certain closing costs and capital improvements. This basis is then divided by 27.5 years to determine the annual depreciation deduction, which is claimed on the investor's tax return each year the property is held as a rental. This deduction is separate from and in addition to actual cash expenses like mortgage interest, property taxes, insurance, and maintenance — depreciation doesn't represent actual cash leaving the investor's pocket, which is why it can create the effect of "paper losses" that reduce taxable income even on a property that's cash-flow positive in real terms. It's important to understand that depreciation isn't a permanent tax benefit — when the property is eventually sold, the IRS requires "depreciation recapture," taxing the accumulated depreciation deductions at a specific rate, separate from regular capital gains tax on the sale. This is one reason some investors use strategies like 1031 exchanges when selling, since exchanging into another investment property can defer both the capital gains tax and the depreciation recapture that would otherwise be due upon sale. Given the complexity of correctly calculating and applying depreciation, working with a tax professional experienced in real estate investment is strongly advisable rather than attempting this calculation independently.