Depreciation
Depreciation is the gradual decrease in the value of an asset over time due to wear and tear, obsolescence, or other factors.
Understanding Depreciation
Depreciation is a tax deduction that allows commercial property owners to recover the cost of the building (excluding land) over its useful life as defined by the IRS. For commercial real estate, the standard depreciation period is 39 years (straight-line method), meaning investors can deduct approximately 2.56% of the building's cost basis each year.
Depreciation is a non-cash deduction—it reduces taxable income without requiring any cash outlay. This creates 'phantom losses' that can shelter rental income from taxation, potentially resulting in positive cash flow with little or no tax liability. For NNN investors receiving passive rental income, depreciation is often the most valuable tax benefit available.
Cost segregation studies can significantly accelerate depreciation by reclassifying building components (electrical systems, plumbing, site improvements) into shorter depreciation categories—5, 7, or 15 years instead of 39. Combined with bonus depreciation provisions, cost segregation can generate massive first-year tax deductions that shelter income from the NNN property and other passive income sources.
When the property is sold, accumulated depreciation must be 'recaptured' at a 25% tax rate—unless the investor uses a 1031 exchange to defer all taxes. This interplay between annual depreciation benefits and eventual recapture creates a strong incentive for long-term holding and strategic 1031 exchange planning in the NNN investment space.
Why Depreciation Matters to Investors
Depreciation is the NNN investor's best friend at tax time. A $2M NNN property (with $400K allocated to land) generates approximately $41,000 in annual depreciation—enough to shelter a significant portion of the rental income from taxation. With a cost segregation study, first-year deductions can reach $200,000+. This tax-advantaged income stream is a primary reason high-income professionals invest in NNN properties. Combined with 1031 exchanges, depreciation enables generational wealth building with minimal current tax liability.
Related CRE Concepts
1031 Exchange
A 1031 exchange (also called a like-kind exchange) is a tax-deferral strategy under IRS Se...
Stepped-Up Basis
A stepped-up basis is a tax provision where the cost basis of an inherited asset is adjust...
Net Operating Income (NOI)
Net operating income (NOI) is the most widely used performance metric in commercial real e...
Cost Approach
The Cost Approach is a method used in real estate appraisal to determine the value of a pr...
Equity
Equity refers to the value of an individual's ownership interest in a business or property...
Learn More
Frequently Asked Questions
How long do you depreciate commercial NNN property?
Commercial real estate is depreciated over 39 years using the straight-line method. Only the building value is depreciable—land cannot be depreciated. A cost segregation study can reclassify certain building components into 5, 7, or 15-year categories, accelerating deductions significantly in the early years of ownership.
What is a cost segregation study for NNN properties?
A cost segregation study is an engineering-based analysis that reclassifies building components into shorter depreciation categories. For a NNN property, this might reclassify 20-35% of the building cost into 5-15 year categories, generating substantial additional depreciation in early years. Studies typically cost $5,000-15,000 and pay for themselves many times over in tax savings.
Does depreciation create taxable income when you sell?
Yes, accumulated depreciation is 'recaptured' upon sale at a 25% tax rate, in addition to capital gains tax on appreciation. For example, if you claimed $200,000 in total depreciation, you'd owe $50,000 in depreciation recapture tax at sale. However, a 1031 exchange defers both depreciation recapture and capital gains taxes, and a stepped-up basis at death can eliminate them entirely.
Can NNN property depreciation offset other income?
NNN property depreciation can offset other passive income. For real estate professionals who meet IRS material participation requirements (750+ hours annually), depreciation can offset active income including W-2 wages. This is why many high-income professionals with real estate professional status actively invest in NNN properties—the depreciation can shelter their primary income from taxation.