How much tax does depreciation actually shelter?

Your participation level

Passive: hands-off, property manager runs it. Active: you make management decisions (approve tenants, set rent). STR + material: avg stay 7 days or less AND material participation (typically 100+ hr and more than anyone else, or 500+ hr) — the “STR loophole.” REPS: >750 hr in real estate trades AND >50% of personal services. See REPS guide for details.

Annual tax shelter value

$0/yr

Active participant — $0 allowance. AGI $180,000 exceeds $150k phaseout. $8,909 loss is fully suspended (passive) — carries forward to offset future passive income, or releases against any income on full taxable disposition (§469(g)).

Pre-tax cash flow (rent − opex − mortgage interest): $2,000/yr(excludes principal paydown — true cash leaving your account is lower)

After-tax cash flow: $2,000/yr ($167/mo)

Plus $8,909 of suspended losses carrying forward indefinitely. Released against future passive income, OR — under §469(g) — against ANY income (W-2, portfolio, gain on the sale itself) when you fully dispose of the activity in a taxable sale to an unrelated party. Real value, just deferred.

The rules in 4 sentences

Depreciation creates paper losses. Building basis (purchase minus land) divided by 27.5 years = your annual non-cash deduction. Often turns cash-flow-positive properties into paper-loss properties for tax purposes.

§469 makes rentals passive by default. Passive losses can only offset passive income. Excess suspends and carries forward indefinitely.

The $25k active-participation allowance lets active participants (low bar) deduct up to $25k against W-2 income — but it phases out 50% from $100k AGI to zero at $150k.

REPS or STR-material-participation bypasses §469 entirely. Losses become non-passive, fully deductible against any income. This is why high-W-2 earners buy STRs or have a non-W-2 spouse manage rentals.

Recapture at sale: all depreciation “allowed or allowable” gets recaptured at max 25% federal (§1250 unrecaptured gain), plus actual gain at LTCG rates. Critical: recapture applies whether or not you actually took the deduction — skipping depreciation doesn’t save you on the back end, it just costs you the front-end deduction. Cost-seg-classified personal property (5/7/15-yr) recaptures at FULL ORDINARY rates under §1245 (no 25% cap). A 1031 exchange defers all of it. See 1031 calculator.

Cost segregation can accelerate depreciation (front-loading $30-50k+ in year 1 on larger properties) but creates ordinary-income recapture on sale. Worth it on buildings $500k+. See full guide for details. Tax law is fact-specific — consult a CPA.