Residential vs Nonresidential Depreciation: 27.5 vs 39 Years

The 80% gross rents test decides the class, and it is applied year by year

Section 168(e)(2)(A) defines residential rental property as any building or structure if 80% or more of its gross rental income for the taxable year is rental income from dwelling units. A dwelling unit is a house or apartment used to provide living accommodations, but not a unit in a hotel, motel or other establishment where more than half the units are used on a transient basis. Nonresidential real property under section 168(e)(2)(B) is section 1250 property that is neither residential rental property nor property with a class life under 27.5 years.

The section 168(c) table assigns 27.5 years to residential rental property and 39 years to nonresidential real property. Section 168(b)(3) requires straight line for both, and section 168(d)(2) the mid-month convention, which treats a building placed in service or sold in any month as placed in service or sold at the midpoint of that month. Publication 946 gives office buildings, stores and warehouses as nonresidential examples and a rental home or mobile home as residential.

The test is measured on gross rents, not floor area, and if you occupy part of the building, section 168(e)(2)(A)(ii)(II) adds the fair rental value of your space to gross rental income. A building where a hotel operator rents rooms nightly is nonresidential even though people sleep there.

Mixed-use buildings are where the class is won or lost

Hypothetical: a main street building collects $180,000 a year from eight apartments and $60,000 from a ground-floor shop. Dwelling units produce 75% of gross rents, under the 80% line, so the whole building is 39-year property. Raise apartment rents to $250,000 with the shop at $50,000 and the share is 83%, so the building is 27.5-year property. The building is not split between classes; the test classifies the entire structure.

Because the test runs every taxable year, a building can cross the line when leases turn over. Reg. section 1.168(i)-4(d) treats a reclassification under section 168(e) caused by a change in use as a change in use. A move to the longer period is depreciated as though the building had been placed in service originally with that period. A move to the shorter period is treated as placed in service in the year of change, unless you elect on a timely return to disregard the change and keep the old schedule.

Main street mixed-use 1031 planning and the mixed-use building page cover the sale side of these buildings.

The 11.5-year gap changes the yearly deduction by about a third, and the recapture rate is the same

On a hypothetical $1,000,000 of depreciable building basis, a full year of straight-line depreciation is about $36,364 over 27.5 years and about $25,641 over 39 years, a difference of roughly $10,700 a year. Land is excluded from both. Over ten years the residential owner has deducted about $107,000 more and has a correspondingly lower basis.

At sale the class does not change the rate. Because both use straight line, section 1250 finds no additional depreciation to recapture as ordinary income for an individual, and all the depreciation becomes unrecaptured section 1250 gain taxed at up to 25% under section 1(h); the 2026 depreciation recapture tax rate page shows how that layer stacks. More depreciation now means more 25% gain later, unless the gain is deferred.

The alternative depreciation system in section 168(g)(2)(C) uses 30 years for residential rental and 40 for nonresidential real property. It is mandatory in some cases and applies to a real property business that elects out of the business interest limit under section 168(g)(8).

Improvements follow the building's class, with one exception for commercial interiors

A new roof or an added apartment generally takes the building's own recovery period. The exception is qualified improvement property: section 168(e)(6) defines it as an improvement to an interior portion of a nonresidential building placed in service after the building was, excluding enlargements, elevators and escalators and the internal structural framework. Section 168(e)(3)(E)(vii) makes it 15-year property, which makes it eligible for bonus depreciation.

Apartment interiors get no equivalent; they stay 27.5-year property unless a component is personal property or a land improvement, which is where cost segregation comes in. Bonus depreciation in 2026 covers what qualifies under the restored 100% rate.

After an exchange the carried-over basis keeps the old schedule unless the replacement's period is longer

Reg. section 1.168(i)-6 governs depreciation of replacement property. The exchanged basis carried over from the property you gave up is depreciated over the relinquished property's remaining recovery period if the periods are the same. If you exchange an apartment building into an office building, the replacement's 39-year period is longer, so the exchanged basis is depreciated as if the office had been placed in service when the apartments were, over 39 years. If you exchange an office into apartments, the shorter 27.5-year period does not apply to the exchanged basis; it keeps the office's remaining 39-year schedule.

Excess basis, the extra basis from new cash or debt, is treated as newly placed in service property with the replacement's own period. Under paragraph (i) of the regulation you can instead elect to treat the entire basis as placed in service at replacement, which restarts the clock and lowers the yearly deduction. A fractional interest in a traditional DST holding apartments or commercial property follows the same rules for your share; depreciating replacement property after a 1031 walks through the computation.