Definition
Depreciation recapture is the tax you pay, when you sell a property at a gain, on the depreciation deductions you took while you owned it. For rental and commercial real estate, that portion of the gain is taxed at your ordinary income rate, capped at 25% federally, instead of the lower long-term capital gains rate.
How depreciation recapture works
Each year you own a rental, you can deduct part of the building’s cost: over 27.5 years for residential rental property and 39 years for commercial property. Land is not depreciated. Those deductions reduce your taxable rental income, but they also reduce your adjusted basis in the property.
When you sell, your gain is the sale price minus that lower adjusted basis. The part of the gain that comes from depreciation you took is taxed differently from the rest:
- Unrecaptured Section 1250 gain: gain equal to straight-line depreciation on buildings. Taxed at your ordinary rate, up to a maximum of 25%.
- Section 1245 recapture: depreciation on personal property such as appliances, carpeting, and components separated out in a cost segregation study, including bonus depreciation. Taxed as ordinary income, up to 37%.
- Remaining gain: appreciation above your original cost basis. Taxed at long-term capital gains rates of 0%, 15%, or 20%.
High-income sellers may also owe the 3.8% Net Investment Income Tax on the whole gain, and state income tax applies on top. Pennsylvania, for example, taxes the full gain at 3.07%.
A worked example
An investor bought a residential rental for $500,000 ($100,000 land, $400,000 building) and sells it 15 years later for $900,000. They are in the top federal bracket and live in Pennsylvania.
| Depreciation taken ($400,000 ÷ 27.5 × 15 years) | $218,182 |
| Adjusted basis ($500,000 − $218,182) | $281,818 |
| Total gain ($900,000 − $281,818) | $618,182 |
| Piece of the gain | Amount | Rate | Tax |
|---|---|---|---|
| Unrecaptured Section 1250 gain (depreciation) | $218,182 | 25% | $54,545 |
| Long-term capital gain (appreciation) | $400,000 | 20% | $80,000 |
| Net Investment Income Tax on the full gain | $618,182 | 3.8% | $23,491 |
| Pennsylvania income tax on the full gain | $618,182 | 3.07% | $18,978 |
| Total estimated tax | $177,015 |
About 40% of the federal capital gains tax ($54,545 of $134,545, before the NIIT) comes from recapturing depreciation, even though the property only appreciated $400,000. The longer you own a property, the larger that share grows.
Hypothetical and simplified: ignores selling costs, capital improvements, the mid-month convention, and the 25% cap interacting with lower brackets. Not a prediction of any actual tax.
Ways to defer or reduce recapture
Defer
1031 exchange
Exchanging into like-kind real estate, including a Delaware Statutory Trust, carries your basis forward and defers recapture along with the rest of the gain.
Defer and diversify
721 exchange
Contributing property to a REIT’s operating partnership defers the gain until units are converted. See 721 exchanges and UPREITs.
Hold
Step-up at death
Under current law, heirs generally receive a basis equal to fair market value at death, which can eliminate deferred recapture entirely. Pennsylvania inheritance tax may still apply.
Offset
Losses and charitable tools
Harvested capital losses can offset the gain, and some owners use charitable remainder trusts or charitable gifts of property as part of an exit plan.
Two limits are worth knowing. An installment sale can spread capital gain over several years, but Section 1245 recapture is generally taxed in the year of sale regardless of when you are paid. And a Qualified Opportunity Zone investment can defer gain reinvested within the required window, with its own rules and deadlines; our opportunity zone guide covers them.
Special situations
- You never claimed depreciation. Recapture is based on depreciation “allowed or allowable,” so it can apply even if you skipped the deduction. A CPA can often catch up missed depreciation with an accounting method change before you sell.
- Selling a former rental that became your home. The home-sale exclusion does not cover depreciation taken after May 6, 1997; that portion is still taxed as recapture.
- Cost segregation and bonus depreciation. Accelerated deductions boost early cash flow but create more Section 1245 recapture taxed at ordinary rates if you later sell without exchanging.
Before you list a property, our DST 1031 exchange calculator gives a rough comparison of exchanging versus paying the tax, and our replacement options comparison lays out where a 1031 can go.
Frequently asked questions
What is depreciation recapture?
Depreciation recapture is the tax owed on the depreciation deductions you took on a property when you sell it for more than its depreciated basis. For residential and commercial real estate, the gain attributable to straight-line depreciation is called unrecaptured Section 1250 gain and is taxed at your ordinary income rate, capped at 25% federally. Depreciation on personal property and cost-segregated components is Section 1245 recapture, taxed as ordinary income.
What is the depreciation recapture tax rate on rental property?
For real estate depreciated on a straight-line basis, the federal rate on recaptured depreciation is your ordinary income rate up to a maximum of 25%. Higher-income sellers may also owe the 3.8% Net Investment Income Tax, plus any state income tax. Gain above the recaptured depreciation is taxed at long-term capital gains rates of 0%, 15%, or 20%.
Can a 1031 exchange avoid depreciation recapture?
A properly completed 1031 exchange defers depreciation recapture along with the rest of the gain by carrying the old property’s basis into the replacement property. The recapture is not eliminated; it can come due when the replacement property is eventually sold in a taxable transaction. Under current law, property held until death may receive a step-up in basis that removes the deferred gain for heirs.
Do I owe depreciation recapture if I never claimed depreciation?
Generally yes. Recapture is based on depreciation allowed or allowable, meaning the depreciation you were entitled to take, even if you did not claim it. Owners who missed depreciation can often correct it with an accounting method change, which a CPA can evaluate.