Residential Rental Property and the 27.5 Year Class

Most small investors own residential rental property, so the 27.5 year class is the default backdrop for their study decision. This page explains what the class covers and where the edges are.

The definition, in general terms

Residential rental property generally means a building or structure where 80 percent or more of the gross rental income is from dwelling units. A dwelling unit is a house or an apartment used to provide living accommodations. Hotels, motels, and similar establishments where more than half of the units are used on a transient basis generally do not count. Buildings that mix dwelling units with commercial space can qualify or not depending on the share of rental income. Confirm your building's status with your preparer.

The depreciation mechanics

Residential rental property is generally depreciated using the straight line method over 27.5 years, using a mid-month convention. The mid-month convention treats the property as placed in service in the middle of the month, so the first year's deduction depends on the month. Land is excluded. The annual deduction in a full year is a little over three and a half percent of the building basis.

What this means without a study

A building with a $300,000 depreciable basis generates about $10,900 per year of depreciation under these rules in full years, in a hypothetical illustration. Everything in the building is treated as part of the structure unless separated.

What a study may identify

A study of a residential rental may separate items such as some flooring, certain appliances and fixtures, cabinetry in some cases, decorative items, and site improvements such as driveways, fences, and landscaping. The share of a residential property's cost that lands in shorter classes varies by property, and this site does not offer a generic percentage. Only a property-specific review would show the number. See Examples of 5 and 7 Year Property in Rentals and Commercial Buildings and Land Improvements and the 15 Year Class.

The furnished rental question

A rental furnished by the owner includes furniture and appliances that are personal property in their own right. Their cost is generally a separate purchase from the building and is typically depreciated on a 5 or 7 year schedule. That is a different question from cost segregation of the building. See Long-Term Rentals: The Study Decision.

Where the classification can get complicated

• Mixed use. A building with apartments over shops may not meet the 80 percent test and might be depreciated as nonresidential property. See Nonresidential Property and the 39 Year Class.
• Short-term rentals. Classification depends on how the property is used and whether it resembles a hotel. Views differ, so ask your preparer. See Short-Term Rentals: The Study Decision.
• Owner-occupied portions. If you live in part of the building, only the rental portion is depreciated.
• Conversions. If you convert a home to a rental, the basis and placed-in-service date follow special rules.

Passive loss considerations

Residential rental activities are generally treated as passive, so losses are subject to limits. There is a limited allowance for owners who actively participate and have income below thresholds. Most owners with larger incomes find losses suspended unless they qualify as real estate professionals. See The Passive Activity Loss Rules and Cost Segregation and Real Estate Professional Status and Study Decisions.

Recapture on sale

A study on a residential rental produces personal property and land improvements whose depreciation can be recaptured on sale. See Depreciation Recapture on Sale: What Comes Back.

Who this class fits

Owners of single-family rentals, duplexes, small apartment buildings, and larger apartment complexes are covered. The economics differ by size. See Multifamily Properties: The Study Decision and Small and Low-Basis Properties.

Cautions

Do not assume that being in the 27.5 year class means a study is or is not worthwhile. The class defines the baseline. The decision depends on the shift, usability, and hold period. See Cost Segregation Decision Checklist.

Illustrative cases in words

A duplex with both units leased to residents for year-long terms clearly meets the residential rental test. A four-story building with apartments above and retail space below may or may not, depending on the share of gross rental income from the apartments. A house rented to guests for short stays raises the classification question discussed on this site. A house that you live in part-time and rent part-time requires allocation. Recognizing which of these describes your property is the first step.

Practical implications for the study

Because the class sets the baseline, studies on residential rentals usually focus on the items that are personal property or land improvements. Owners often find that interior finishes in modest rentals are simple and that the shift is modest. Owners of upscale properties or those with substantial site features may find more. This is a generalization and should not be used as an estimate.

Recordkeeping

Keep leases, rent rolls, and documentation of the use of each part of the building. These support the residential classification and the allocation between rental and personal use. Also keep records of when each unit was placed in service, especially if units were brought online at different times after renovation.

Next steps

Read Long-Term Rentals: The Study Decision for the decision perspective on a typical rental, and Depreciation Classes: 5, 7, 15, 27.5, and 39 Years for the broader picture.