What is Depreciation Recapture?
Depreciation recapture is the tax owed when you sell a depreciated asset like rental property — the IRS "recaptures" the tax benefit of prior depreciation deductions by taxing the gain at a higher rate than typical long-term capital gains.
Depreciation recapture is a tax provision that requires you to pay tax on the portion of a gain from selling a depreciable asset — like rental property or business equipment — that was previously deducted as depreciation expense. In effect, the IRS is recapturing the tax savings you received from those deductions.
When you own rental property, you can deduct a portion of the property's value each year as depreciation (typically over 27.5 years for residential real estate). This deduction reduces your taxable income every year. When you sell the property, the IRS wants to tax the portion of your gain that was sheltered by those deductions.
How Depreciation Recapture Works
Step 1: Calculate your adjusted cost basis
$$\text{Adjusted Basis} = \text{Original Purchase Price} + \text{Capital Improvements} - \text{Total Depreciation Claimed}$$
Step 2: Calculate your gain on sale
$$\text{Gain} = \text{Sale Price} - \text{Adjusted Basis}$$
Step 3: Determine how much of the gain is recapture
The amount of gain up to the total depreciation you claimed is subject to recapture. The rest is a capital gain taxed at standard capital gains rates.
Example:
- You buy a rental property for $200,000
- Over 10 years, you claim $72,727 in depreciation ($200,000 ÷ 27.5 years × 10 years)
- You sell for $310,000
- Your adjusted basis: $200,000 − $72,727 = $127,273
- Your total gain: $310,000 − $127,273 = $182,727
- Of that gain, $72,727 is depreciation recapture; $110,000 is a capital gain
Tax Rate on Depreciation Recapture
For real property (residential and commercial real estate), depreciation recapture is taxed as unrecaptured Section 1250 gain at a maximum rate of 25% — lower than ordinary income rates but higher than the typical 15% long-term capital gains tax rate.
For personal property and equipment (Section 1245 property), recapture is taxed at ordinary income rates, which can be higher.
| Asset Type | Recapture Rate |
|---|---|
| Residential rental property | Up to 25% (Sec. 1250) |
| Commercial real estate | Up to 25% (Sec. 1250) |
| Equipment, furniture (Sec. 179 or bonus depreciation) | Ordinary income rates |
Depreciation Recapture and Real Estate Investing
Depreciation recapture is one of the most overlooked costs in real estate investing. Many new investors calculate their expected return based on the purchase price and expected sale price — without factoring in the tax bill on sale.
The key insight: Even if you never actually claimed the depreciation deduction, the IRS still calculates recapture based on the depreciation you were allowed to take. This rule catches investors who didn't take depreciation deductions they were entitled to.
Strategies to Minimize Depreciation Recapture
- 1031 exchange — Defer both capital gains and depreciation recapture by rolling proceeds into a like-kind property. This is the most powerful deferral tool available to real estate investors.
- Hold until death — Property transferred at death receives a stepped-up basis, eliminating all deferred depreciation recapture
- Installment sale — Spread income over multiple years to manage your tax bracket exposure
- Charitable strategies — Donate appreciated property to charity or a charitable remainder trust to avoid recapture entirely (consult a tax advisor)
Depreciation Recapture on Rental Property vs. Primary Residence
If you convert a primary residence to a rental property, you begin claiming depreciation. When you sell, depreciation recapture applies to the period it was used as a rental — even if the property was originally your home. The $250,000/$500,000 primary residence exclusion does not offset depreciation recapture, adding complexity to these situations.
Consult a CPA or tax advisor if you're selling any property that was depreciated. The interplay of capital gains rates, recapture rates, and exclusion rules can vary significantly based on your situation.