Depreciation

Depreciation is the accounting practice of spreading an asset's cost over its useful life. For US rental property it is a tax deduction for the building, not the land. It is not part of NOI, so it does not change the cap rate, but it can change the after-tax return a lot.

The IRS schedule is 27.5 years for residential rental property and 39 years for commercial property, straight line. If $400,000 of the example property's $500,000 price is building, the annual deduction is about $14,545, which can shelter much of the NOI from income tax.

Cap rate stays pre-tax because investors' tax situations differ. Two buyers of the same property see the same cap rate but different after-tax returns. Depreciation deducted over the years is generally taxed at sale through depreciation recapture.