Real Estate Depreciation for Physicians: Separating Tax Strategy from Sale Pitch

Of all the alternative investment options marketed to physicians, real estate probably gets the most traction.  And I understand why. 

Doctors tend to have more discretionary income, even after maxing out their 401(k), and the smart ones are looking for ways to leverage that income for their futures, rather than just spending it on a fancier lifestyle. 

Because of that draw, a whole industry has emerged—physician real estate investing.  And with any industry that involves money, there are people giving good advice and people giving bad advice—and even some downright charlatans. 

My disclaimer here is that I do believe in the power of real estate as an investment tool when done correctly and when going into it with eyes wide open.  I have some active real estate investments myself. 

Two of the powers of real estate are:  leverage and diversification from the stock market.  This post is not about those things though.  I want to focus more on the purported tax benefits that come with real estate investing.

I was recently asked my opinion about investing in short-term rentals by a client who was approached by a company who specialize in this for doctors.  As is often the case, he was referred to them by a physician friend. 

One of their selling points was the tax advantages of real estate investing—depreciation in particular.  Physicians, often in the highest tax brackets, are particularly vulnerable to this pitch. 

Again, it is not the goal of this post to vet that specific company.  They might very well have cracked the code for a consistent, fantastic passive revenue stream from short-term rentals. But I did want to give some further general information about depreciation when it comes to investing in real estate in particular. 

Because in the famous words of Inigo Montoya from the classic movie The Princess Bride, “You keep using that word.  I do not think it means what you think it means.”

What is depreciation?

In its simplest definition, depreciation is a non-cash expense that lets you deduct the “wear and tear” of a property over time. 

Not all property is treated the same.  Depending on what kind of property it is, the depreciation rules and timeframe are different.  Here is a chart of the useful life of common depreciable assets:

Asset	Useful Life
Autos	5  years
Computers	5 years
Heavy Machines	7 years
Office Furniture	7 years
Residential Real Estate	27.5 years
Non-residential (Commercial) Real Estate	39 years

To be depreciable, the property (or asset) must meet all the following requirements:

1.      It must be property owned by the taxpayer

2.      It must be used in a business or an income-producing activity

3.      It must have a determinable useful life (see above)

4.      It must be expected to last more than 1 year.

Depreciation begins when the property is placed in service for use in a trade or business or to produce income. Depreciation stops when either the cost has been fully recovered or when it is retired from service (or sold). 

Applying the depreciation rules to real estate investing

So let’s apply the rules:

Rule #1:  To depreciate the property, you have to own it.  You can receive depreciation as a passive investor in a syndicate or fund—typically passed through on a K-1—but it is still subject to passive loss limitations.

Rule #2:  The property has to be specifically intended to generate income or be part of a business—i.e. you cannot depreciate your second home if you don’t rent it out. 

Rule #3:  It does have a determinable useful life.  Residential property is 27.5 years. 

Commercial property is 39 years.  This only applies to the value of the structure on the property, not the land.  Land does not depreciate. You can choose to depreciate the portions of the property inside the structure at their individual useful lives.  For example, furniture, TVs, appliances, carpet, fixtures, landscaping would all depreciate at different rates.  This is known as a cost segregation study, where components of the property are reclassified into shorter depreciation schedules.  It is usually done by engineers and tax specialists and will cost you some money up front. 

Rule #4:  It has to be expected to last for one year.  This is easily covered with real estate. 

Calculating real estate depreciation

Assuming that you meet all the requirements above, you calculate the depreciation by starting with the cost of the property (what you paid for it), then allocate a portion to land (which is not depreciable), and finally, depreciate the remaining property value over its useful life.  This gives  you an annual depreciation figure using the straight-line method.

There are other ways to calculate this number and some techniques that allow you to depreciate more in the early years instead of spreading it evenly across the useful life.  I’m going to talk a little bit more about that in the “bonus depreciation” section below, since that was one of the selling points to my client of working with this company.

Depreciation recapture

Depreciation can be a powerful tax tool during ownership—but it comes with an important tradeoff when you sell.   When you sell the property, the IRS adjusts your cost basis downward by the depreciation you’ve taken over the years.  This increases your taxable gain. 

The portion of that gain attributable to depreciation is called unrecaptured Section 1250 gain and is taxed at your ordinary income rate, capped at 25% (plus potential state and net investment income taxes).  Any gain beyond your original purchase price is taxed at long-term capital gains rates. 

In other words, some of the tax savings you enjoyed during ownership are effectively “paid back” through depreciation recapture when you sell—unless you have a strategy in place to defer or offset them.  

Let’s walk through a simplified example. 

• Purchase price:  $1,000,000

  • Land:  $200,000 (not depreciable)

  • Building: $800,000

• Over 10 years: you take a total depreciation of $300,000.

• Your adjusted cost basis:

  • $1,000,000 (original price) - $300,000 (depreciation) = $700,000

    
    

• Now, you sell the property for $1,200,000

  • Total gain: $1,200,000 - $700,000 = $500,000

    
    

How that gain is taxed:

• Depreciation recapture

  • First $300,000 (the depreciation you took)

  • Taxed at up to 25% federal (plus state and NIIT taxes)

• Remaining capital gain:

  • $500,000 - $300,000 = $200,000

  • Taxed at long-term capital gains rates (15-20%)

    
    

What this means: 

Even though you benefited from $300,000 in depreciation over the years, a portion of those tax savings is effectively “paid back” when you sell the property.  This doesn’t mean depreciation isn’t valuable—it just means the benefit is primarily one of timing, not permanent tax elimination. 

Tax Rate Arbitrage

One of the potential benefits of depreciation is tax rate arbitrage. If you are able to deduct depreciation while in a higher tax bracket and later pay taxes on that depreciation at a lower rate (capped at 25% federally), the difference can work in your favor.

However, this benefit is not guaranteed. It depends on your ability to actually use the deductions when they occur, as well as your tax situation at the time of sale. Even when rates are similar, the ability to defer taxes and use that money earlier still provides a meaningful advantage.

For investors who are able to consistently use losses and strategically manage their tax situation, these benefits can be meaningful—but they are highly dependent on execution.

Bonus depreciation

I mentioned above that there are ways that you can front-load some of the depreciation and get more of the tax break in the early years of ownership.  In fact, with the Tax Cuts and Jobs Act of 2017, they created a very generous rule regarding real estate depreciation known as bonus depreciation.   It basically says that qualified components of a property (via cost segregation) can be expensed up to 100% in year 1, when the property is placed in service.  That can give a great tax break and is often how marketers are selling real estate investing to physicians. 

Here is the problem.  The rule is rapidly phasing out.  It started at 100% in properties placed in service in 2022.  But it is losing 20% each year until it phases out completely in 2027.  So that means that if you buy a property and place it in service by 2026, you can only apply bonus depreciation to 20% of the eligible components.  And if you wait until 2027, bonus depreciation is no longer allowed (unless extended by Congress).

While it’s still possible to generate meaningful first-year deductions—especially in larger deals or with specific strategies—the era of routinely writing off a large portion of a property in year one has largely passed with the phase-out of bonus depreciation.

The income rules

The other thing to keep in mind is that, as a physician, real estate is considered passive income for you.  It is not your primary job.  That means that losses from real estate depreciation can only be used to offset passive income—not your physician salary. 

So, if your property generates $20,000 in income and $30,000 in depreciation, you have a $10,000 passive loss.  As a physician,  you generally cannot use that loss against your W2 income.  Instead, the loss is suspended and carried forward to future years—where it can offset future passive income or be used when the property is sold. 

The good news is that your depreciation can offset your passive rental income, reducing or even eliminating the taxable income from the property.  And you are accumulating passive losses that can be used in the future—often when you sell the property—to offset gains, including depreciation recapture and capital gains. 

The bad news is that it doesn’t lower your tax bill each year nearly as much as you thought it was going to. 

Now, if you (or your spouse) start doing real estate full time, then you can write off the losses against all  your active income, including your physician salary. This requires meeting specific IRS criteria, including working at least 750 hours per year in real estate activities and more time in real estate than in any other profession. Thus, becoming an active real estate investor is a large hurdle if you plan to continue working as a doctor.

Bottom line: depreciation doesn’t eliminate taxes—it changes the timing of taxes. And that timing only matters if you can actually use the deduction.

There are some exceptions—most notably with certain short-term rental structures—where losses may not be treated as passive if specific IRS material participation criteria are met. However, these situations require careful planning and are not the default for most physicians. These exceptions are often highlighted in marketing materials—but they depend heavily on execution, documentation, and ongoing involvement, which is why they don’t apply as broadly as they’re sometimes presented.

When Depreciation Can Make a Big Difference

At this point, it might sound like I’m saying that depreciation isn’t all that useful. That’s not the case. There are specific situations where depreciation can be extremely valuable—especially for physicians who structure their investments intentionally.

1. When you have other passive income

   If you already have passive income—from other rental properties, real estate syndications, or passive business investments—depreciation can directly offset that income and reduce your tax bill.

   
   

2. When you or your spouse qualifies as a real estate professional

   If you (or more commonly, your spouse) meet IRS criteria for real estate professional status, depreciation losses can be used to offset active income—including your physician salary. This is where depreciation strategies can have a significant impact, but it requires a meaningful commitment to real estate activity.

   
   

3. When you plan to hold and eventually sell the property

   Even if you can’t use the losses today, they aren’t lost. Suspended losses carry forward and can be used in the future—often becoming most valuable when you sell the property and need to offset capital gains and depreciation recapture.

   
   

4. When paired with a broader tax strategy

   Depreciation becomes more powerful when it’s part of a larger plan—rather than being the sole reason to invest in real estate.

   
   

Summary

Let me reemphasize that there are a lot of really good reasons to include real estate in your investment portfolio: 

1.      The leveraging power is real—where you purchase an appreciating asset for only a portion of the total cost and sell at a profit. 

2.      Real estate is not highly correlated with the stock market and can therefore balance out some of those ups and downs.

3.      There are various ways to do it—from owning properties directly to investing in a syndicate for a multi-family project to simply investing in a private real estate fund or even publicly-traded REIT.

4.      There are some tax advantages

But real estate investing also comes with rules, warnings, and some things to keep in mind:

1.      Owning properties comes with risk.  They require upkeep. There are expenses. You can get a bad renter who damages your property. They can go unrented for a period of time. They don't always appreciate in value.

2.      Leverage comes with risk.  It is relatively easy for physicians to borrow money. Enticing, even.  But if you borrow too much and then something goes wrong, you are on the hook to pay back loans even if you are not getting the income that you expected.  This can add stress and means that you have to work harder as a physician to make up the difference.

3.      To take advantage of most of the tax rules, real estate investments need to be set up as a business which requires oversight and you need to understand all the nuances of the law.

The goal here is not to discourage you away from this asset class.  It can be powerful.  It is to be sure that you are going into it with eyes wide open and not swayed by the tax-driven sales pitches that sound compelling—but often misrepresent the full picture.   

If you are interested in seeing how real estate works within the context of a comprehensive financial plan, schedule an appointment with me through Targeted Wealth Solutions.

Disclaimer: the material in this blog post is intended for general educational purposes only and should not be considered specific financial advice. You should always consult with your personal financial advisor to see how it might fit within your personalized financial plan.