There is not really a downside, but just a consequence that many people do not really think about. It makes logical sense, once someone explains it, but it might not occur to you ahead of time.
Suppose you pay $65,000 for a rental house. You own it for exactly one year, and then you sell it for $65,000. There is no gain, so you have no taxable income on the transaction.
But what if you owned it for a little over one year and wrote off $2,000 of depreciation deductions? You get the benefit of $2,000 worth of tax benefits in the current year. The IRS will not let you sell the property for $65,000 and pay no income taxes. It says, “You received $2,000 worth of tax benefits last year, so we are going to take back some of those benefits this year.”
For purposes of calculating gain on the sale, you have to subtract that $2,000 from your $65,000 purchase price and treat the property as if you bought it for only $63,000. This is called your basis. Every year that you take depreciation deductions (but not any other normal expenses), you have to reduce your basis in the same amount as the depreciation deductions. In the example, you sell the property for $65,000 and you had a basis of $63,000, so your gain is $2,000.
You might think that the depreciation does not help you at all. It really does, though. You receive tax deductions against each year’s taxable income. You save money at your highest tax rate for that year. Yes, you pay taxes in a later year when you sell the property, but that is in the future when inflation makes your dollars cheaper.
Also, if you qualify for long-term capital gains tax rates, then the highest rate is 15% instead of the highest individual tax rate of 35%. As a result, your deductions save you money at 35%, and paying taxes later costs you only 15%, so you really do win.
Furthermore, if you use a 1031 exchange, then you do not have to pay any taxes at all, even when you sell the property.