[Depreciation Recapture](/blog/depreciation-real-estate-guide) on Rental Property: How to Calculate and Minimize Tax When Selling

Depreciation is one of [rental property investing](/blog/best-cities-for-rental-income-2026)'s greatest tax benefits—until you sell. Depreciation recapture taxes require you to repay some of those tax savings when you dispose of the property, often catching investors by surprise with five-figure tax bills.

Understanding depreciation recapture, how it's calculated, and strategies to minimize or defer it is essential for maximizing after-tax returns when selling rental properties.

This comprehensive guide explains depreciation recapture mechanics, calculation methods, and proven strategies to reduce your tax burden when exiting real estate investments.

What Is Depreciation Recapture?

Depreciation recapture is the IRS's method of taxing the gain on depreciable property at ordinary income rates (up to 25%) rather than the more favorable long-term capital gains rates (typically 15-20%).

Why Recapture Exists

When you depreciate rental property:

• You receive tax deductions each year
• Deductions reduce your taxable income
• Lower taxable income = lower taxes paid

However, depreciation also reduces your property's cost basis:

• Lower basis = higher taxable gain when selling
• IRS requires "recapturing" (taxing) depreciation taken at up to 25%

The IRS wants its money back—at least partially.

Real-World Example

Purchase and depreciation:

• Purchase price: $500,000
• Land value: $100,000
• Depreciable basis: $400,000
• Depreciation over 10 years: $145,455 (residential 27.5-year schedule)
• Tax bracket: 35%
• Tax savings from depreciation: $50,909

Sale after 10 years:

• Sale price: $650,000
• Original cost basis: $500,000
• Less depreciation taken: -$145,455
• Adjusted basis: $354,545
• Capital gain: $295,455 ($650,000 - $354,545)

Tax calculation:

• Depreciation recapture: $145,455 × 25% = $36,364
• Remaining capital gain: $150,000 ($295,455 - $145,455) × 20% = $30,000
• Total tax: $66,364

You saved $50,909 over 10 years but pay back $36,364 at sale, netting $14,545 in tax benefit plus time value of money advantage.

Section 1250 vs. Section 1245 Property

The IRS treats different property types differently for recapture purposes.

Section 1250 Property (Real Property)

Includes:

• Residential rental buildings (apartments, houses)
• Commercial buildings (offices, retail, warehouses)
• Structural components
• Land improvements (parking lots, landscaping, fencing)

Recapture rate:

• Maximum 25% (unrecaptured Section 1250 gain)
• Lower than ordinary income rates
• More favorable treatment

Why it matters:

• Most rental property is Section 1250
• Depreciation recaptured at 25% maximum
• Better than ordinary income rates (up to 37%)

Section 1245 Property (Personal Property)

Includes:

• Appliances and equipment
• Furniture and fixtures
• Carpeting and window treatments
• Personal property within buildings
• Assets depreciated through cost segregation as 5, 7, or 15-year property

Recapture rate:

• Full ordinary income rates (up to 37%)
• Harsher tax treatment
• All gain up to original basis taxed at ordinary rates

Cost segregation impact:

• Assets reclassified to shorter lives via cost segregation
• Recaptured at ordinary rates (not 25%)
• Trade-off: upfront tax savings vs. higher recapture later

See our cost segregation guide for details on this strategy.

Calculating Depreciation Recapture

Step-by-Step Calculation

Step 1: Determine adjusted basis

Original cost basis
- Accumulated depreciation
- Other basis reductions
= Adjusted basis

Step 2: Calculate total gain

Sale price
- Selling costs
- Adjusted basis
= Total gain

Step 3: Separate gain components

Total gain split into:
1. Depreciation recapture (lesser of total depreciation or gain)
2. Remaining capital gain (if any)

Step 4: Calculate taxes

Depreciation recapture × 25% = Recapture tax
Remaining capital gain × 20% = Capital gains tax (or 0%/15% based on income)
Total tax = Recapture tax + Capital gains tax

Detailed Example

Property details:

• Purchase price: $800,000 (including $150,000 land)
• Depreciable basis: $650,000
• Ownership period: 15 years
• Total depreciation: $354,545
• Sale price: $1,200,000
• Selling costs: $60,000

Calculation:

Adjusted basis:

• Original basis: $800,000
• Less depreciation: -$354,545
• Adjusted basis: $445,455

Total gain:

• Sale price: $1,200,000
• Less selling costs: -$60,000
• Net proceeds: $1,140,000
• Less adjusted basis: -$445,455
• Total gain: $694,545

Gain breakdown:

• Depreciation recapture: $354,545 (all depreciation taken)
• Remaining capital gain: $340,000 ($694,545 - $354,545)

Tax calculation (assuming highest brackets):

• Depreciation recapture: $354,545 × 25% = $88,636
• Capital gain: $340,000 × 20% = $68,000
• Total tax: $156,636

After-tax proceeds:

• Net proceeds: $1,140,000
• Less taxes: -$156,636
• Less mortgage payoff (if any)
• Net after-tax: $983,364

Factors Affecting Recapture Tax

1. Depreciation Method Used

Straight-line depreciation (most common):

• Section 1250 recapture at maximum 25%
• Only method allowed for residential rentals after 1986
• Most favorable recapture treatment

Accelerated depreciation (commercial pre-1987):

• Additional recapture at ordinary rates
• Amount above straight-line recaptured at ordinary rates
• Less common today

2. Property Type

Residential (27.5-year schedule):

• Section 1250 treatment
• 25% maximum recapture rate

Commercial (39-year schedule):

• Section 1250 treatment
• 25% maximum recapture rate
• Same as residential

Personal property (cost seg assets):

• Section 1245 treatment
• Ordinary income rates (up to 37%)
• Less favorable

3. Holding Period

Impact on total gain (not recapture rate):

• Longer holds = more depreciation taken
• More depreciation = higher recapture
• Appreciation offsets some impact

No holding period requirement for recapture:

• Unlike capital gains (1-year requirement)
• Recapture applies even on short-term holds

4. Income Tax Bracket

Capital gains rates by income (2026):

• 0%: Single <$47,025, Joint <$94,050
• 15%: Single $47,025-$518,900, Joint $94,050-$583,750
• 20%: Above these thresholds

Depreciation recapture:

• Always 25% maximum (Section 1250)
• Not affected by income level
• Additional 3.8% Net Investment Income Tax (NIIT) if income >$200K single, $250K joint

5. Cost Segregation Impact

Properties with cost segregation face higher recapture:

Without cost segregation:

• All depreciation at 25% (Section 1250)

With cost segregation:

• Structural components: 25% (Section 1250)
• Personal property: Ordinary rates up to 37% (Section 1245)
• Bonus depreciation: Ordinary rates

Example:

• $200,000 total depreciation
• $50,000 from cost-segregated personal property
• Recapture: ($150,000 × 25%) + ($50,000 × 37%) = $37,500 + $18,500 = $56,000

Without cost seg:

• Recapture: $200,000 × 25% = $50,000

Difference: $6,000 additional recapture

Despite higher recapture, cost segregation usually provides net benefit due to time value of money and upfront deductions.

State Tax Implications

States with Income Tax

Most states require paying state income tax on recaptured depreciation:

State treatment varies:

• Some conform to federal treatment
• Some tax all gain at ordinary rates
• Some have special capital gains rates

High-tax states particularly impactful:

• California: Up to 13.3% state tax
• New York: Up to 10.9% state tax
• New Jersey: Up to 10.75% state tax

Combined federal + state rates:

• Federal depreciation recapture: 25%
• State tax: 5-13%
• NIIT: 3.8%
• Total: 33.8-41.8%

No-Income-Tax States

Tax advantages:

• Texas, Florida, Nevada, Tennessee, Washington, Wyoming, South Dakota, Alaska, New Hampshire
• No state tax on recapture
• Only federal rates apply
• Significant savings for high-value properties

Example savings:

• Depreciation recapture: $200,000
• California seller: $200,000 × 13.3% = $26,600 state tax
• Texas seller: $0 state tax
• Savings: $26,600

Strategies to Minimize Depreciation Recapture

Strategy 1: 1031 Exchange (Most Powerful)

How it works:

• Sell property and reinvest proceeds in replacement property
• Defer ALL taxes including depreciation recapture
• No current tax due
• Basis carries forward to replacement property

Requirements:

• Like-kind property (any real estate for any real estate)
• 45-day identification period
• 180-day closing period
• [Qualified intermediary](/blog/1031-exchange-rules-2026) required
• Equal or greater value replacement property

Benefits:

• Complete tax deferral
• Recapture deferred indefinitely
• Can repeat with successive exchanges
• Build wealth faster by keeping tax dollars invested

Example:

• Sell property with $150,000 recapture due
• 1031 exchange into replacement property
• Recapture deferred
• Tax savings: $37,500 (at 25%) + time value of money

Can continue exchanging for life, or hold until death for step-up in basis.

Learn more in our 1031 exchange guide.

Strategy 2: Hold Until Death (Step-Up in Basis)

How it works:

• Don't sell during lifetime
• Property passes to heirs at death
• Basis "steps up" to fair market value at death
• Heirs avoid all depreciation recapture and capital gains

Tax elimination:

• All depreciation recapture forgiven
• All capital gains forgiven
• Heirs inherit with new basis = current value

Example:

• Property worth $1.5M at death
• Original basis: $500,000
• Depreciation taken: $300,000
• Capital appreciation: $1,000,000

If sold before death:

• Depreciation recapture: $300,000 × 25% = $75,000
• Capital gains: $700,000 × 20% = $140,000
• Total tax: $215,000

If inherited with step-up:

• Heirs' basis: $1,500,000
• No recapture, no capital gains
• Tax savings: $215,000

Estate planning note: Properties held in revocable trusts still receive step-up. Irrevocable trusts have different rules.

Strategy 3: Installment Sale

How it works:

• Seller finances part of purchase price
• Receive payments over multiple years
• Spread gain recognition (and recapture) over time

Tax timing:

• Recapture recognized proportionally
• Spreads tax payments over multiple years
• May reduce tax bracket impact in any single year

Limitations:

• Depreciation recapture recognized in year of sale (not spread)
• Only remaining capital gain spreads over installment period
• Interest income taxable annually

Revised: Recapture rules: Under IRC Section 453(i), depreciation recapture must be recognized in year of sale even with installment method. Only capital gain above recapture spreads over time.

Benefit primarily for capital gain portion, not recapture itself.

Strategy 4: [Opportunity Zone](/blog/1031-exchange-vs-opportunity-zones) Deferral

How it works:

• Invest capital gains (not recapture) in [Qualified Opportunity Zone](/blog/opportunity-zone-investing) Fund
• Defer capital gains until 2026 or until investment sold
• Potential elimination of gains on QOZ investment after 10 years

Limitation:

• Only defers capital gains, NOT depreciation recapture
• Recapture still due in year of sale
• Limited benefit for recapture specifically

Better for:

• Deferring capital appreciation gains
• Not ideal specifically for recapture relief

Strategy 5: Maximize Basis Before Sale

Increase basis to reduce gain:

• Capital improvements add to basis
• Renovations, additions, major systems
• Document all improvements with receipts

Impact:

• Higher basis = lower total gain
• Doesn't avoid recapture but reduces capital gain portion
• Every $1 increase in basis saves $0.20 (at 20% cap gains rate)

Example:

• Pre-sale renovations: $50,000
• Basis increase: $50,000
• Capital gain reduction: $50,000
• Tax savings: $10,000 (at 20%)

Strategy 6: Partial Sales or Partial 1031 Exchanges

Split property:

• Sell portion outright (pay taxes)
• 1031 exchange remaining portion (defer taxes)
• Control timing and amount of tax

Cash boot:

• Receive some cash at sale
• Pay taxes on that portion
• Defer remainder through exchange

Flexibility for cash needs while still deferring majority of tax.

Strategy 7: Convert to Primary Residence

[Section 121 exclusion](/blog/capital-gains-home-sale):

• $250,000 gain exclusion (single), $500,000 (married)
• Must be primary residence 2 of last 5 years
• Depreciation taken after 2008 still recaptured
• Complex rules for converted rental properties

Depreciation recapture still applies:

• Non-qualified use periods
• Post-2008 depreciation not eligible for exclusion
• Pre-2009 depreciation may qualify

Limited benefit due to recapture rules, but some tax savings possible in right circumstances.

Strategy 8: Time Sale Strategically

Tax bracket management:

• Sell in low-income year
• Retirement year (after job loss before pension starts)
• Coordinate with other deductions

Capital loss harvesting:

• Realize capital losses same year
• Offset gains dollar-for-dollar
• $3,000 ordinary income offset if excess losses

Multi-year planning:

• Split sales across multiple years if multiple properties
• Manage tax brackets
• Avoid NIIT threshold crossings

Special Situations

Partnership or LLC Sale

Entity-level considerations:

• Depreciation recapture passes through to partners
• Reported on K-1
• Each partner pays tax based on personal situation
• May be subject to Section 751 "hot asset" rules

Short Sales or Foreclosures

Deemed sales:

• Foreclosure or short sale = disposition
• Triggers depreciation recapture
• Cancellation of debt income may also apply
• May qualify for insolvency exclusion

Partial Dispositions

Disposing of portions:

• Retiring component parts
• Partial disposition election
• Recapture on disposed portions
• Remaining property continues depreciating

[Like-Kind Exchange](/blog/1031-exchange-for-beginners) Basis Tracking

Successor basis rules:

• Replacement property basis = adjusted basis of relinquished property
• Carries forward depreciation recapture potential
• Tracks through multiple exchanges
• Due when eventually sell without exchanging

Record Keeping for Recapture Calculation

Essential Records to Maintain

Purchase documentation:

• Closing statement (HUD-1 or settlement statement)
• Purchase contract
• Title policy
• Initial appraisal with land/building allocation

Depreciation records:

• Annual tax returns showing depreciation taken
• Depreciation schedules by year
• Cost segregation studies (if performed)
• Asset detail for personal property

Improvements and basis adjustments:

• Receipts for capital improvements
• Contractor invoices
• Permits
• Before/after photos
• Separate tracking for repairs vs. improvements

Sale documentation:

• Sales contract
• Closing statement
• Real estate commission documentation
• Transfer tax receipts

Hold period:

• 3+ years after final tax return filed
• Longer recommended (7 years safer)
• Permanent retention advised for long-term investments

Working with Tax Professionals

When to Hire Help

Essential situations:

• Cost segregation studies performed
• Multiple properties or complex partnerships
• Considering 1031 exchange
• Disputed basis calculations
• State tax complexities
• IRS audit or examination

Types of Professionals

CPA or enrolled agent:

• Tax calculation and return preparation
• Recapture computation
• Multi-state returns
• Audit representation

Real estate tax specialist:

• Cost segregation expertise
• 1031 exchange coordination
• Complex transactions
• Planning strategies

Qualified intermediary:

• Required for 1031 exchanges
• Holds funds during exchange
• Ensures compliance
• Documentation preparation

[Real estate attorney](/blog/how-to-build-real-estate-team):

• Partnership agreements
• Complex transactions
• Disputed ownership or basis issues

Cost-Benefit Analysis

Professional fees typically $1,000-$5,000+:

• Returns often 10x+ the fee in tax savings
• Reduces audit risk
• Ensures compliance
• Peace of mind

Especially valuable for:

• Properties with $100,000+ gains
• Multiple properties sold
• Cost segregation involved
• Planning future transactions

Conclusion

Depreciation recapture is an unavoidable reality for real estate investors claiming depreciation deductions. While you must eventually pay tax on recaptured depreciation, strategic planning can minimize, defer, or even eliminate these taxes.

The most powerful strategy—1031 exchanges—allows indefinite deferral by continuously reinvesting in replacement properties. Combined with eventual step-up in basis at death, investors can potentially avoid recapture taxes entirely while building substantial wealth through real estate.

For immediate sales, understanding recapture calculations, maximizing basis, and timing sales strategically can reduce tax impact. Working with experienced tax professionals ensures optimal tax treatment and compliance.

The key is planning ahead: consider recapture implications before selling, explore all deferral options, and structure transactions to minimize taxes while achieving investment objectives.

For investors looking to expand portfolios through 1031 exchanges or other acquisitions, HonestCasa's DSCR loans provide financing based on property income, making growth strategies more accessible.

Related Articles

• 1031 Exchange Rules 2026: Complete Tax-Deferral Guide
• Cost Segregation Study Guide: Accelerate Depreciation
• Real Estate Professional Status: Unlock Unlimited Deductions
• Rental Property Tax Deductions: Complete Guide
• Capital Gains Tax on Real Estate: Strategies to Minimize