Depreciation
Depreciation is a tax deduction that allows businesses and property investors to spread the cost of assets (machinery, vehicles, equipment, furniture) over their useful life rather than claiming the full cost in the year of purchase. IRD publishes approved depreciation rates for thousands of different asset types.
For rental property investors, depreciation applies to chattels and fixtures within the property — things like carpets, curtains, appliances, and heat pumps — but not the building structure itself. Commercial and industrial buildings can be depreciated. Correctly claiming depreciation can significantly reduce taxable rental income.
There are two methods: diminishing value (DV), where the deduction decreases each year as the asset's book value falls, and straight line (SL), where the same amount is claimed each year. DV generally gives larger deductions in earlier years. When you sell a depreciated asset for more than its book value, you may need to pay depreciation recovery income.
How it works
Depreciation is really a timing benefit rather than a permanent deduction for assets that hold or gain value. When you eventually sell a depreciated asset for more than its adjusted tax book value, the gain (up to the total amount of depreciation you've claimed) is added back to your taxable income as depreciation recovery income, clawing back the earlier tax benefit.
Once you've chosen a depreciation method — diminishing value or straight line — for a particular asset, you generally need to keep using that method for the life of that asset; you're free to choose a different method for the next asset you buy, but you can't switch back and forth on the same one.
For residential rental property specifically, only the chattels and fixtures inside the property (carpets, curtains, appliances, heat pumps) can be depreciated — the building structure itself cannot. Commercial and industrial buildings are treated differently and remain depreciable, which is why the deduction categories differ so much between a residential landlord and a commercial property owner.
Example: depreciation recovery income on a sale
An investor bought a heat pump for a rental property for $3,000 and had claimed $1,200 of depreciation by the time the property sold, reducing its adjusted tax book value to $1,800 ($3,000 − $1,200).
The heat pump's portion of the eventual sale price works out to $2,500 — more than its $1,800 book value but less than its original $3,000 cost.
The $700 gain over book value ($2,500 − $1,800) is added back as depreciation recovery income, since it's less than the $1,200 previously claimed. If the sale price had instead exceeded the original $3,000 cost, only the full $1,200 previously claimed would be recovered — any amount above the original cost is treated separately, not as recovered depreciation.
Frequently asked questions
Can I choose to depreciate the building structure of my rental property?
No — only the chattels and fixtures inside a residential rental property, such as carpets, appliances, and heat pumps, can be depreciated; the building structure itself cannot be depreciated for tax purposes. Commercial and industrial buildings are treated differently and remain depreciable.
Can I switch between diminishing value and straight line partway through owning an asset?
Generally no — once you've chosen a depreciation method for a specific asset you need to keep using it for that asset's life, though you can pick a different method for the next asset you buy.
What happens if I sell a depreciated asset for less than its book value?
You get an additional deduction (a loss on disposal) rather than recovery income — it's only when the sale price exceeds the adjusted tax book value that some or all of the previously claimed depreciation gets added back as taxable income.
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