Depreciation Recapture: What Real Estate Investors Need to Know Before They Sell

Depreciation recapture is the tax surprise that catches real estate investors off guard at the sale. You’ve been taking depreciation deductions for years — reducing your taxable income and lowering your annual tax bill. Then you sell the property, and the IRS wants some of that money back.

What Is Depreciation Recapture?

When you sell, the IRS “recaptures” the tax benefit it previously granted on your depreciation deductions. Every dollar of depreciation you deducted over the years is now subject to tax at sale. For real property, this is called Unrecaptured Section 1250 Gain and is taxed at a maximum federal rate of 25% — regardless of how long you held the property.

How the Math Works

Example: Purchase price $300,000 (building $260,000, land $40,000). Depreciation over 10 years: $260,000 ÷ 27.5 × 10 = $94,545. Adjusted basis: $300,000 − $94,545 = $205,455. Sale price: $450,000. Total gain: $244,545. Of that, $94,545 is depreciation recapture taxed at up to 25%. The remaining $150,000 is a capital gain taxed at long-term rates.

You Owe Recapture Even If You Didn’t Take the Deduction

The IRS taxes depreciation recapture based on the amount you were allowed to deduct — not what you actually claimed. If you failed to take depreciation in prior years, you still owe recapture tax at sale. There is a remedy: file Form 3115 to catch up on unclaimed depreciation. Talk to a CPA.

Strategies to Minimize or Defer Recapture

• 1031 Exchange: The most powerful tool. The entire gain including recaptured depreciation is deferred. See our 1031 exchange guide for details
• Hold until death: Heirs receive a stepped-up basis, potentially eliminating accumulated recapture tax permanently
• Installment sale: Can spread capital gains but note — depreciation recapture must be recognized in full in the year of sale

Plan Before You Sell

Depreciation recapture is plannable. Know your adjusted basis, your total depreciation taken, and your expected recapture exposure before you sign a listing agreement. Then decide whether an exchange, installment structure, or outright sale makes the most sense for your situation.