Depreciation Recapture Tax on Real Estate: Rates, Calculation, and How to Defer It
Understand the 25% recapture tax, how to estimate potential exposure, and strategies to defer it when selling investment property.
Key Takeaway
Depreciation recapture is a federal tax mechanism that may apply at up to 25% to the portion of a real estate sale gain attributable to prior depreciation deductions. Under the 'allowed or allowable' rule, the IRS generally applies recapture whether or not the owner actually claimed the deductions. A 1031 exchange is the most widely used strategy for deferring both depreciation recapture and capital gains tax.
This content is for educational purposes only and does not constitute tax or legal advice. Tax laws are complex and subject to change. Consult a qualified tax professional before making decisions.
Real estate investors who claim depreciation deductions during ownership often face an unexpected tax bill when they sell. The IRS generally allows owners of investment property to deduct depreciation each year, reducing taxable rental income. When the property is sold, the IRS may require the owner to recognize a portion of that prior tax benefit as income through depreciation recapture.
Depreciation recapture is the federal tax applied to the portion of a sale gain attributable to prior depreciation deductions. For real property, this tax generally applies at a maximum rate of 25%. It is separate from, and in addition to, any long-term capital gains tax owed on the appreciation above the original purchase price. Depreciation recapture is one of several tax implications real estate investors may want to evaluate before selling.
This guide covers how depreciation recapture works on real estate, the current tax rates, a step-by-step calculation with a worked example, and strategies to defer or minimize this tax. It is written for real estate investors, rental property owners, and anyone considering a sale of depreciated investment property. Understanding this tax before selling can be an important part of evaluating potential net proceeds.
How Does Depreciation Recapture Work on Real Estate?
The IRS allows owners of investment real estate to depreciate the value of buildings and improvements over a set period. Residential rental property is depreciated over 27.5 years. Commercial property is depreciated over 39 years. Both use the straight-line method, meaning equal annual deductions over the property's useful life. Land is not depreciable.
These depreciation deductions reduce taxable rental income each year. They also reduce the property's adjusted basis (the value the IRS assigns to the investment for tax purposes). When the property is sold for more than its adjusted basis, the IRS generally treats the depreciation taken as recaptured taxable income.
Two sections of the Internal Revenue Code govern how this recapture is taxed.
Section 1250 (real property). This applies to buildings and structural components depreciated under the straight-line method. The gain attributable to depreciation is classified as "unrecaptured Section 1250 gain" and is generally subject to a maximum rate of 25%. For most real estate investors who used straight-line depreciation, all depreciation recapture generally falls under this category.
Section 1245 (personal property). This applies to shorter-lived assets that were reclassified through a cost segregation study, such as appliances, carpeting, cabinetry, and certain fixtures. Depreciation recapture on these items is generally taxed at the investor's ordinary income tax rate, which can be as high as 37%.
The distinction matters. If only straight-line depreciation was used on the building itself, recapture is generally capped at 25%. Investors who accelerated depreciation through cost segregation may find that some portion of the recapture is taxed at ordinary income rates. Most residential rental property investors who did not use a cost segregation study will generally see their recapture taxed under Section 1250 at the 25% maximum — though the actual rate depends on the investor's overall tax picture.
What Is the Depreciation Recapture Tax Rate?
The depreciation recapture tax rate depends on the type of property and how it was depreciated.
Unrecaptured Section 1250 gain (real property) is generally taxed at a maximum rate of 25%. The applicable rate is generally the lesser of 25% or the investor's ordinary income tax rate. Investors in the 10% or 12% tax brackets may generally pay their ordinary rate on recapture. Investors in the 22% bracket and above generally face the 25% maximum, though actual rates depend on individual tax circumstances.
Section 1245 recapture (personal property reclassified via cost segregation) is generally taxed at the investor's ordinary income tax rate, up to 37%.
Beyond depreciation recapture, there are additional taxes that may apply to the total gain when selling investment property.
| Tax Component | Rate | What It Applies To |
|---|---|---|
| Depreciation recapture (Section 1250) | Up to 25% | Gain attributable to straight-line depreciation on real property |
| Section 1245 recapture | Ordinary income (up to 37%) | Gain on personal property reclassified via cost segregation |
| Long-term capital gains | 0%, 15%, or 20% | Gain above original purchase price (appreciation) |
| Net Investment Income Tax (NIIT) | 3.8% | Investment income for MAGI above $200,000 (single), $250,000 (MFJ), or $125,000 (MFS) |
| State income tax | Varies | Depends on state of residence and property location |
The NIIT thresholds have not been adjusted for inflation since the tax was introduced in 2013. Tax rates are current as of 2026. Rates may change with future legislation. Consult a qualified tax professional for guidance specific to your situation.
How to Calculate Depreciation Recapture on Real Estate
Calculating depreciation recapture generally involves five steps. This overview is for educational purposes only — actual calculations depend on individual tax circumstances and should be completed with a qualified tax professional.
Step 1: Determine the original cost basis.
Start with the purchase price. Add closing costs and any capital improvements made during ownership. Subtract the value of the land, since land is not depreciable.
Step 2: Calculate total depreciation claimed (or allowed).
Divide the depreciable basis by the applicable recovery period (27.5 years for residential rental, 39 years for commercial) and multiply by the number of years the property was owned. One critical rule to understand: the IRS generally calculates depreciation recapture based on the depreciation the owner was "allowed or allowable" to take, regardless of whether it was actually claimed on tax returns. Even if the deduction was never claimed, the IRS generally calculates recapture as though it was.
Step 3: Determine the adjusted basis.
Subtract total depreciation from the original cost basis (including improvements). The result is the adjusted basis.
Step 4: Calculate total gain on sale.
Subtract the adjusted basis and any selling expenses from the sale price.
Step 5: Separate the gain into its tax components.
The depreciation recapture portion equals the total depreciation claimed (or allowable), generally subject to a rate of up to 25%. The capital gain portion equals the remaining gain above the original cost basis, generally subject to long-term capital gains rates.
Hypothetical Example: Residential Rental Property
Consider a hypothetical investor who purchased a residential rental property for $500,000, with $100,000 allocated to land and $400,000 to the building. The investor owned the property for 10 years using straight-line depreciation and made $25,000 in capital improvements.
- Annual depreciation: $400,000 / 27.5 = $14,545 per year
- Total depreciation over 10 years: $14,545 x 10 = $145,455
- Adjusted basis: $500,000 + $25,000 (improvements) - $145,455 (depreciation) = $379,545
The property sold for $650,000 net of selling expenses.
- Total gain: $650,000 - $379,545 = $270,455
This gain breaks into two components:
- Depreciation recapture: $145,455 potentially subject to up to 25% = approximately $36,364 estimated federal tax
- Capital gain: $650,000 - $525,000 (original basis plus improvements) = $125,000 potentially subject to a 15% rate = approximately $18,750 estimated federal tax
Estimated total federal tax: approximately $55,114 (before state taxes and any applicable NIIT). Actual results vary.
This example is hypothetical and for educational purposes only. Actual tax liability depends on the investor's complete tax picture, filing status, and applicable deductions. Actual results will vary. Consult a qualified tax professional.
How to Avoid or Defer Depreciation Recapture Tax on Real Estate
Several strategies may help reduce or defer depreciation recapture tax. The appropriate approach for a given investor generally depends on their investment timeline, estate planning goals, and overall tax situation. Consult a qualified tax professional to evaluate which strategies may apply.
1031 Exchange
A 1031 exchange under IRC Section 1031 is the most widely used strategy for deferring depreciation recapture. By exchanging investment property for a like-kind replacement property of equal or greater value, investors may be able to defer both capital gains tax and depreciation recapture tax. For a complete breakdown of rules, timelines, and requirements, see our complete 1031 exchange guide.
The deferred depreciation carries over to the replacement property through a carryover basis under IRC Section 1031(d). The replacement property generally inherits the relinquished property's depreciated basis, preserving the deferred recapture liability. Investors can potentially chain 1031 exchanges, deferring recapture with each successive exchange, subject to IRS rules.
A 1031 exchange defers depreciation recapture. It does not eliminate it. If the property is eventually sold without exchanging, the accumulated recapture generally becomes due. Strict rules apply: 45-day identification period, 180-day closing deadline, and proceeds must be held by a Qualified Intermediary. For a complete breakdown of tax deferral strategies including depreciation recapture, see our tax strategies guide for real estate investors.
Some investors also hold exchanged properties through death, at which point heirs may receive a stepped-up basis under IRC Section 1014 — potentially eliminating the deferred recapture. This is an estate planning consideration to discuss with a qualified CPA and estate attorney.
Section 121 Exclusion (Converting Rental to Primary Residence)
If an investor converts a rental property to a primary residence and lives in it for at least two of the five years before selling, the investor may qualify for the Section 121 exclusion of up to $250,000 in gain ($500,000 for married couples filing jointly).
Rules enacted in 2008 limit this strategy. Gain attributable to nonqualified use (rental periods after December 31, 2008) is generally prorated and excluded from the Section 121 benefit. Under IRS Publication 523, depreciation claimed after May 6, 1997 is generally not eligible for the exclusion and may remain subject to recapture at up to 25%. This strategy may partially reduce overall tax liability but generally does not eliminate depreciation recapture.
How Bonus Depreciation and Cost Segregation Affect Recapture
Investors who have used cost segregation studies to accelerate depreciation face a more complex recapture picture at sale. Understanding how different asset categories are taxed upon disposition is important for accurate planning. For more on how cost segregation and accelerated depreciation work, see our Cost Segregation Study Guide.
A cost segregation study reclassifies building components into shorter depreciation categories (5-year, 7-year, and 15-year property). Each category carries different recapture treatment at sale.
Section 1245 personal property (appliances, carpeting, cabinetry, fixtures with 5-year or 7-year lives): recapture is generally taxed at ordinary income rates, up to 37%. This is typically the highest-rate recapture category and often the largest accelerated depreciation component.
Land improvements (parking lots, landscaping, sidewalks, and fencing with 15-year lives): recapture falls under Section 1250 at a maximum rate of 25%.
Structural components remaining on the standard 27.5-year or 39-year schedule: standard Section 1250 recapture at up to 25%.
Bonus depreciation amplifies the recapture exposure. Investors who claimed 100% bonus depreciation on reclassified Section 1245 assets may find the full deducted amount is subject to recapture at ordinary income rates upon sale. For example, a hypothetical investor who took $200,000 in bonus depreciation on 5-year property could potentially face recapture at rates up to 37% on that entire amount, compared to the 25% maximum on standard building depreciation. Actual results vary based on individual tax circumstances.
This increased recapture exposure from cost segregation and bonus depreciation is a key reason 1031 exchanges are commonly used by these investors. The exchange may defer the entire recapture obligation, including the higher-rate Section 1245 portion, potentially allowing investors to reinvest the full proceeds into replacement property.
Depreciation Recapture Tax: Frequently Asked Questions
What is depreciation recapture tax on real estate?
Depreciation recapture is a federal tax that generally applies when investment real estate is sold for more than its adjusted basis. Under Section 1250, the gain attributable to prior depreciation deductions is generally taxed at a maximum rate of 25% for real property.
What is the depreciation recapture tax rate?
For real property (Section 1250), the maximum rate is 25%. For personal property reclassified through cost segregation (Section 1245), the rate is the investor's ordinary income tax rate, up to 37%. High earners may also owe the 3.8% NIIT.
Do I owe depreciation recapture even if I didn't claim depreciation?
Under the IRS "allowed or allowable" rule, recapture is generally based on the depreciation the owner was entitled to take, whether or not it was claimed. Failing to claim depreciation generally does not reduce recapture exposure at sale. Consult a qualified tax professional regarding your specific situation.
How can I avoid depreciation recapture on rental property?
The most common strategy is a 1031 exchange, which defers both capital gains and depreciation recapture by reinvesting in like-kind property. Investors who convert a rental property to a primary residence may also qualify for a partial Section 121 exclusion.
Can a 1031 exchange eliminate depreciation recapture?
A 1031 exchange defers recapture but does not eliminate it. The deferred amount carries forward through the carryover basis. However, if the investor continues exchanging and the property passes to heirs, the step-up in basis under current law may potentially eliminate the accumulated recapture — though applicable tax law is subject to change.
What happens if I sell a fully depreciated rental property?
The entire gain up to the total depreciation claimed is generally subject to recapture tax at up to 25%. Any gain above the original cost basis may be taxed at long-term capital gains rates of 0%, 15%, or 20%, depending on the investor's income and filing status. Consult a qualified tax professional for guidance specific to your situation.
Next Steps: Plan Before You Sell
Depreciation recapture can represent a significant portion of the tax owed when selling investment property, and many investors underestimate the potential impact. The 25% maximum rate generally applies to the full amount of depreciation claimed over the entire ownership period. The "allowed or allowable" rule means that investors who did not claim depreciation may still face recapture exposure, as the IRS generally calculates recapture based on the amount allowable — not just amounts actually claimed.
Understanding potential recapture exposure before listing a property is an important part of evaluating exit strategy options.
For investors facing significant depreciation recapture exposure, a 1031 exchange may help defer both capital gains and recapture taxes when reinvesting into a replacement property. Anchor1031 has completed over 300 1031 transactions and provides access to pre-vetted replacement properties through our DST marketplace. Schedule a consultation to discuss how a tax-deferred exchange fits into your exit strategy.
Consult a qualified tax professional to evaluate your specific depreciation recapture exposure and determine an appropriate strategy for your situation.
In Summary
- Depreciation recapture on real property is generally subject to a maximum rate of 25% under Section 1250
- Under the IRS "allowed or allowable" rule, recapture generally applies whether or not the deductions were claimed
- Cost segregation and bonus depreciation can increase recapture exposure to ordinary income rates (up to 37%)
- A 1031 exchange is the most widely used strategy to defer both depreciation recapture and capital gains tax
- Step-up in basis at death may potentially eliminate accumulated recapture for heirs, depending on applicable law at that time
About the Author
Thomas Wall, Partner
Thomas Wall is a Partner at Anchor1031, where he specializes in educating clients about 1031 exchanges, private real estate offerings, and REITs. With nearly a decade of experience in alternative investments and real estate, Mr. Wall has helped investors through hundreds of 1031 exchanges, placing over $230M of equity into real estate.
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Disclosure
Tax Complexity and Investment Risk
Tax laws and regulations, including but not limited to Internal Revenue Code Section 1031, bonus depreciation rules, cost segregation studies, and other tax strategies, contain complex concepts that may vary depending on individual circumstances. Tax consequences related to real estate investments, depreciation benefits, and other tax strategies discussed herein may vary significantly based on each investor's specific situation and current tax legislation. Anchor1031, LLC and Great Point Capital, LLC make no representation or warranty of any kind with respect to the tax consequences of your investment or that the IRS will not challenge any such treatment. You should consult with and rely on your own tax advisor about all tax aspects with respect to your particular circumstances. Please note that Anchor1031 and Great Point Capital, LLC do not provide tax advice.
The information contained in this article is for general educational purposes only and does not constitute legal, tax, investment, or financial advice. This content is not a recommendation or offer to buy or sell securities. The content is provided as general information and should not be relied upon as a substitute for professional consultation with qualified legal, tax, or financial advisors.
Tax laws, regulations, and IRS guidance regarding 1031 exchanges, opportunity zone investments, and related real estate strategies are complex and subject to change. Information herein may include forward-looking statements, hypothetical information, calculations, or financial estimates that are inherently uncertain. Past performance is never indicative of future performance. The information presented may not reflect the most current legal developments, regulatory changes, or interpretations. Individual circumstances vary significantly, and strategies that may be appropriate for one investor may not be suitable for another.
All real estate investments, including 1031 exchanges and opportunity zone investments, are speculative and involve substantial risk. There can be no assurance that any investor will not suffer significant losses, and a loss of part or all of the principal value may occur. Before making any investment decisions or implementing any 1031 exchange strategies, readers should consult with their own qualified legal, tax, and financial professionals who can provide advice tailored to their specific circumstances. Prospective investors should not proceed unless they can readily bear the consequences of potential losses.
While the author is a partner at Anchor1031, the views expressed are educational in nature and do not guarantee any particular outcome or create any obligations on behalf of the firm or author. Neither Anchor1031 nor the author assumes any liability for actions taken based on the information provided herein.