Depreciation Recapture: The Tax Bill That Surprises Rental Sellers

What Depreciation Recapture Is

While you own a rental, the IRS lets you deduct depreciation each year, treating the building as if it slowly wears out. Those deductions lower your taxable income and are one of the biggest tax advantages of rental real estate.

Depreciation recapture is the other side of that benefit. When you sell, the IRS wants to reclaim the tax advantage you received. The portion of your gain attributable to depreciation you took, or were allowed to take, is taxed at a special recapture rate rather than the lower long-term capital gains rate.

How It Is Calculated

When you sell, your gain is split. The part of the gain equal to the depreciation you claimed is unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%. Any remaining gain above that is taxed at standard long-term capital gains rates.

A critical detail catches many owners off guard: recapture applies to depreciation you were allowed to take, whether or not you actually claimed it. Skipping depreciation does not avoid recapture, so there is rarely a reason not to take it.

Worked Example

Suppose you bought a rental with a $275,000 building basis and depreciated it over several years, claiming $50,000 of depreciation. Your adjusted basis drops by that $50,000. When you sell at a gain, the first $50,000 of gain is unrecaptured Section 1250 gain taxed up to 25%.

If your total gain is $130,000, then $50,000 is subject to recapture and the remaining $80,000 is taxed at long-term capital gains rates. State taxes may apply on top. Investors who forget recapture often underestimate the true tax cost of selling.

Ways to Reduce or Defer It

• Use a 1031 exchange to defer both capital gains and depreciation recapture by rolling into a like-kind property.
• Hold the property longer so depreciation benefits compound before any eventual sale.
• Consider timing a sale in a lower-income year to manage overall tax brackets.
• Keep careful records of capital improvements, which increase basis and can reduce total gain.
• Work with a qualified tax professional before selling, since recapture interacts with your full tax picture.

Why It Still Usually Pays to Depreciate

Some owners consider skipping depreciation to avoid recapture, but this almost never helps. Recapture applies to depreciation allowed, not just taken, so you would owe the tax anyway while giving up years of deductions.

Depreciation also defers tax into the future and can be avoided entirely through a 1031 exchange or a step-up in basis at death. Taking the deduction and planning the exit is almost always better than forfeiting the benefit.

Frequently Asked Questions