Depreciation Recapture

What is depreciation recapture?

Depreciation recapture is the IRS collecting back the benefit of depreciation when you sell. Every year of deductions lowered your property’s cost basis; at sale, the portion of your gain created by that basis reduction (technically "unrecaptured Section 1250 gain" for real estate) is taxed at your ordinary income rate capped at 25%, rather than the lower long-term capital gains rates that apply to the remaining appreciation.

The math surprises sellers because recapture applies even if the property never appreciated. Buy a building for $200,000, deduct $50,000 of depreciation, and sell for $200,000: your basis is now $150,000, so you have a $50,000 gain, all of it recapture taxed at up to 25%. Recapture is also computed on depreciation "allowed or allowable," meaning you owe it even on deductions you failed to claim.

The main escape hatches are the same as for capital gains: a 1031 exchange defers recapture along with the rest of the gain, and holding until death eliminates it through the stepped-up basis heirs receive. For everyone else, recapture is best understood as an interest-free loan from the IRS, decades of tax-sheltered cash flow repaid at sale at a capped rate.

Worked example

You bought a rental for $250,000, took $60,000 of depreciation (basis now $190,000), and sell for $310,000. Total gain = $120,000. The first $60,000 (the recapture portion) is taxed at up to 25% (up to $15,000); the remaining $60,000 of appreciation is taxed at long-term capital gains rates (e.g. 15%, or $9,000).

Frequently asked questions

Can I avoid depreciation recapture by not claiming depreciation?

No, this is one of the tax code’s cruelest traps. Recapture is calculated on depreciation "allowed or allowable," so the IRS taxes you at sale as if you had claimed every year’s deduction whether or not you actually did. Skipping depreciation forfeits the annual benefit while keeping the exit cost. If you have failed to claim it, a Form 3115 filing can catch up the missed deductions before sale.

What tax rate applies to depreciation recapture?

For real estate, unrecaptured Section 1250 gain is taxed at your ordinary income rate but capped at 25%. That sits above the 15% long-term capital gains rate most investors pay on appreciation, which is why sale proceeds get split into two differently-taxed buckets. High earners may also owe the 3.8% net investment income tax on top of both buckets.

Related tools and guides

• Capital Gains on Rental Property
• 1031 Exchange Calculator