What is depreciation recapture and how much tax do I owe when I sell a rental property?
Depreciation recapture is one of the most overlooked tax traps for landlords. When you sell a rental property, the IRS "takes back" the tax benefit you received from depreciation deductions over the years — and taxes that recaptured amount at a special rate.
How depreciation works (the setup):
When you own a rental property, you deduct a portion of the building's value each year as depreciation (typically 1/27.5 of the cost basis annually for residential property). This reduces your taxable rental income every year. Over 10 years on a $275,000 building, you'd have claimed $100,000 in depreciation deductions.
What happens when you sell:
The IRS calculates your gain using your adjusted basis — which is your original cost minus all the depreciation you claimed (or could have claimed). This inflates your apparent gain:
- Original cost: $275,000
- Depreciation claimed over 10 years: $100,000
- Adjusted basis: $175,000
- Sale price: $350,000
- Total gain: $175,000
The $100,000 in depreciation is "recaptured" and taxed at up to 25% (the "unrecaptured Section 1250 gain" rate). The remaining $75,000 gain is taxed at regular long-term capital gains rates (0%, 15%, or 20%).
The two tax rates on your gain:
| Portion of Gain | Tax Rate | Source |
|---|---|---|
| Depreciation recapture (unrecaptured §1250) | Up to 25% | IRS § 1(h)(1)(D) |
| Long-term capital gain above that | 0%, 15%, or 20% | Based on your income |
| Depreciation on personal property (§1245) | Ordinary income rates | Less common for rentals |
How to report it: Use Form 4797 (Sales of Business Property) to calculate the recapture, then carry the results to Schedule D.
Can you avoid depreciation recapture?
- 1031 Exchange: If you exchange the property for another qualifying like-kind property, recapture is deferred until you sell the replacement property
- Die holding the property: Your heirs receive a stepped-up basis, eliminating both the capital gain and recapture (though this may change under future legislation)
- Installment sale: Spreading the proceeds over multiple years can smooth out the tax hit but does not eliminate recapture — the recapture portion must be recognized in the first year of sale
- Tax-loss harvesting: Offset gains with capital losses from other investments
One frequently missed trap: Even if you didn't actually claim depreciation (maybe you weren't aware you could), the IRS still recaptures the amount you could have claimed. You don't escape it by skipping the deduction.
Sources
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