Depreciation Recapture Explained for Real Estate Investors

Depreciation is one of real estate's best tax benefits: each year you own a rental, you deduct a portion of the building's value against your income, even as the property may be rising in value. But that benefit isn't free forever. When you sell, the IRS "recaptures" the depreciation you claimed, taxing it at a rate that can exceed the long-term capital gains rate. Many investors are blindsided by it at closing. This memo explains what depreciation recapture is, how it's calculated, why it's taxed the way it is, and how a 1031 exchange defers it. It's general information, not tax advice.

What depreciation recapture is

While you own a rental property, you depreciate the building (not the land) over its useful life — 27.5 years for residential rental, 39 for commercial — deducting a slice of its value each year against your income. Those deductions reduce your taxable income annually, and they also reduce your basis in the property. Depreciation recapture is the mechanism that, at sale, taxes the gain attributable to all that depreciation. In effect, the IRS lets you take the deductions along the way, then collects on them when you sell — recognizing that part of your "gain" is really the reversal of deductions you already enjoyed. Understanding it requires connecting it to how the overall gain is calculated.

Why it's taxed at up to 25%

Here's the part that stings: the recaptured depreciation — technically unrecaptured Section 1250 gain — is taxed at a federal rate of up to 25%, higher than the 0/15/20% long-term capital gains rates that apply to the rest of your gain. The logic is that your original depreciation deductions offset ordinary income (taxed at potentially high rates), so the recapture is taxed at a rate above the capital gains rate to claw back part of that benefit. The result is that a sale is effectively taxed in tiers: the depreciation portion at up to 25%, the remaining appreciation at the long-term rate, and the 3.8% net investment income tax potentially on top of both.

How it's calculated

In simplified terms, the depreciation you claimed (or were entitled to claim) over your ownership is the amount subject to recapture, up to the total gain. Because depreciation reduced your basis each year, your adjusted basis at sale is lower than your original cost, which increases your gain — and the portion of that gain equal to the accumulated depreciation is taxed as recapture rather than at the lower capital gains rate. A critical wrinkle: recapture applies to depreciation that was "allowed or allowable," meaning the IRS taxes it whether or not you actually took the deductions. Skipping depreciation doesn't avoid recapture; it just forfeits the benefit while keeping the cost. This is why claiming depreciation properly each year matters.

Recapture versus capital gain

It helps to see the two parts of a sale clearly. Suppose you bought a rental, claimed depreciation over the years, and sell at a profit. Part of your gain reflects genuine appreciation (the property is worth more than you paid) and part reflects the basis reduction from depreciation. The appreciation portion gets the favorable long-term capital gains rate; the depreciation portion is recaptured at up to 25%. For a long-held, heavily depreciated property, the recapture portion can be substantial — sometimes the larger share of the gain — which is why the effective tax on such a sale is often much higher than the headline capital gains rate suggests.

How a 1031 exchange defers recapture

The good news for investors who want to keep their capital working: a 1031 exchange defers depreciation recapture along with the capital gain. Roll the proceeds into like-kind replacement property and neither the appreciation tax nor the recapture comes due — both carry forward in your basis. A DST achieves the same deferral passively. And if you hold the final property until death, the stepped-up basis your heirs receive can eliminate the deferred recapture entirely. So recapture, like the capital gain itself, is something you can defer indefinitely with the right strategy — turning a 25% drag into deferred, potentially eliminated, tax.

Planning around recapture

Two practical lessons follow. First, always claim your depreciation — since recapture applies whether or not you took the deductions, declining them forfeits the annual benefit while leaving the sale-time cost intact. Second, factor recapture into any sale decision: when you model the tax on selling, include the up-to-25% recapture, not just the capital gains rate, so you see the true cost — and the true value of deferring it through an exchange. Investors who account for recapture up front are rarely surprised at closing, and they're far better positioned to decide whether to sell, exchange, or hold. As always, run the specifics with your CPA.

Frequently Asked Questions

Glossary

Depreciation Recapture

Tax due at sale on the depreciation deductions claimed while owning the property.

Unrecaptured Section 1250 Gain

The depreciation-related portion of a real estate gain, taxed at up to 25% federally.

Allowed or Allowable

The rule that recapture applies to depreciation you could have claimed, whether or not you did.

Adjusted Basis

Original cost plus improvements minus depreciation; a lower basis from depreciation increases taxable gain.

Disclosures