Depreciation Recapture: The Tax Nobody Budgets For
Almost every investment property seller I talk to has the same number in their head. They bought at $400,000, they're selling at $900,000, so the gain is $500,000 and at 15% or 20% the tax is somewhere around $100,000.
Buyer cash → Assignment Co. → A-rated carrier → You, on schedule
Then we pull the depreciation schedule and the number moves. Sometimes by six figures.
Depreciation recapture is the part of your gain that gets clawed back at a higher rate because you already deducted it. It isn't a penalty and it isn't optional. It is the IRS collecting on deductions you took in earlier years, and it comes off the top before anything gets the favorable capital gains rate.
The rule that catches people: "allowed or allowable"
You owe recapture on the depreciation you could have taken, not just what you actually claimed.
If you owned a rental for twelve years and your preparer never depreciated it, the IRS still calculates recapture as though you had. You gave up the deductions and you still owe the tax on them. This is the single worst outcome in this area of the code, and it is more common than it should be with self-prepared returns and inherited rentals.
If that describes you, talk to a CPA about Form 3115 before you sell, not after.
Two kinds of recapture, taxed very differently
Section 1250 — real property (the building). For residential and commercial buildings placed in service after 1986, depreciation is straight-line, so the recaptured amount becomes unrecaptured Section 1250 gain and is taxed at a maximum 25% rate. Not 15%, not 20%. It sits in its own bucket.
Section 1245 — personal property (equipment, fixtures, appliances, machinery). This is recaptured as ordinary income at your regular bracket, which currently tops out at 37%. If you did a cost segregation study to accelerate deductions into 5-, 7- and 15-year property, this is the bill arriving. Cost segregation is still often worth it, but it front-loads deductions and back-loads ordinary-income recapture, and sellers rarely model the second half.
Land is not depreciable, so land carries no recapture.
What it actually costs
A $900,000 sale on a property bought for $400,000, held twelve years, with $175,000 of accumulated depreciation:
The recapture piece alone is $43,750 that never appears in the back-of-envelope math, and the depreciation also lowered your basis, which is what made the gain $500,000 instead of $325,000 in the first place.
Run your own numbers in the capital gains tax calculator — it asks for prior depreciation specifically because of this.
The part that surprises even advisors: recapture can't be spread
An installment sale under IRC §453 lets you spread capital gain across the years you actually receive payments. It does not let you spread recapture.
Under §453(i), recapture income is recognized in full in the year of sale, no matter how the payments are structured. You can defer the capital gain portion. The recapture portion is due now.
This matters for planning in a specific way: if your gain is mostly recapture, an installment structure does much less for you than if your gain is mostly appreciation. Anyone who tells you a structure defers "the whole tax bill" on a heavily depreciated property has not read the statute.
What actually reduces it
- A 1031 exchange defers both the gain and the recapture, as long as you follow the identification and closing deadlines and don't take boot. Boot triggers recapture first.
- Holding until death. Heirs receive a stepped-up basis and the recapture liability disappears. Grim, but it is genuinely part of the planning conversation for older owners.
- Allocating the purchase price correctly. In a negotiated sale, how the contract splits value between land, building and personal property changes the recapture math. This is negotiable and it is usually left on the table.
- Timing the sale into a lower-income year, which helps the ordinary-income §1245 portion.
What does not help: hoping your preparer forgets. The depreciation is on your prior returns.
Frequently asked
Q: What is the depreciation recapture tax rate? A: Unrecaptured Section 1250 gain on real property is taxed at a maximum of 25%. Section 1245 property is recaptured as ordinary income, up to 37%. Both sit on top of any regular capital gains tax and potentially the 3.8% net investment income tax.
Q: Do I owe recapture if I never claimed depreciation? A: Yes. The rule is "allowed or allowable." The IRS computes recapture on the depreciation you were entitled to take whether or not you took it. Form 3115 may let you correct missed depreciation before a sale.
Q: Does a 1031 exchange avoid depreciation recapture? A: It defers it rather than avoiding it. A fully qualifying exchange carries both the gain and the recapture into the replacement property. Receiving boot triggers recognition, and recapture is taxed first.
Q: Can an installment sale spread depreciation recapture? A: No. IRC §453(i) requires recapture income to be recognized in the year of sale even when the rest of the gain is spread over future payments.
Q: Is depreciation recapture worth avoiding by not depreciating? A: No. You will owe the recapture either way under the allowed-or-allowable rule, so declining to depreciate means paying the tax without ever getting the deduction.
Run your specific numbers
The calculator runs your sale through real 2026 federal + state tax brackets and shows §453 savings vs lump sum side-by-side.
Run the calculator → 317-463-6659