Depreciation Recapture Tax: How to Calculate What You Actually Owe When You Sell

What Depreciation Recapture Actually Is

The IRS lets rental property owners deduct a portion of the property's cost each year to account for wear and tear. For residential rental property, that schedule runs 27.5 years under the Modified Accelerated Cost Recovery System (MACRS). For commercial property, it runs 39 years.

Every deduction you claimed reduced your taxable income in the year you took it. At sale, the IRS recaptures those deductions. It treats the accumulated depreciation as ordinary income, up to a maximum federal rate of 25% under Section 1250. That rate applies regardless of how long you held the property.

This is not the same as your long-term capital gains rate. A taxpayer in the 20% long-term capital gains bracket still pays 25% on the recaptured depreciation portion of the gain. The two taxes apply to two separate slices of the same transaction.

The Three Numbers You Must Know Before You Calculate

1. Original Cost Basis

Your original cost basis is the purchase price plus closing costs, legal fees, and any capital improvements made during ownership. It does not include routine maintenance or repairs expensed in prior years.

Example: You paid $420,000 for a rental duplex. You spent $18,000 on a roof replacement and $7,500 on a bathroom remodel. Original cost basis equals $445,500.

2. Accumulated Depreciation

Only the structure depreciates, not the land. You must allocate the purchase price between land and building. County tax assessments provide a reasonable starting ratio, though a formal appraisal is more defensible.

If the tax assessment allocates 20% to land, the depreciable basis on the $420,000 purchase is $336,000. Over 27.5 years, annual depreciation equals $12,218. After 12 years of ownership, accumulated depreciation equals $146,618.

Capital improvements also depreciate on their own schedules. The $18,000 roof replacement depreciates over 27.5 years ($654/year). After 12 years, that adds $7,854 to accumulated depreciation. The bathroom remodel follows the same logic.

Total accumulated depreciation in this example: approximately $155,000.

3. Adjusted Cost Basis

Adjusted cost basis equals original cost basis minus accumulated depreciation.

$445,500 minus $155,000 equals $290,500.

This is the number the IRS uses to calculate your total gain. It is almost always substantially lower than what you paid.

Worked Example 1: Residential Rental Property

Scenario: Single property investor, married filing jointly, taxable income of $310,000 including the sale.

• Purchase price: $420,000
• Capital improvements: $25,500
• Original cost basis: $445,500
• Accumulated depreciation (12 years): $155,000
• Adjusted cost basis: $290,500
• Sale price: $610,000
• Selling costs (commissions, fees): $36,600
• Net sale price: $573,400

Total gain: $573,400 minus $290,500 equals $282,900.

Depreciation recapture portion: $155,000, taxed at 25%. Recapture tax: $38,750.

Remaining capital gain: $282,900 minus $155,000 equals $127,900. At the 15% long-term capital gains rate (applicable at this income level): $19,185.

Net Investment Income Tax (NIIT): If modified adjusted gross income exceeds $250,000 for married filers, a 3.8% NIIT applies to investment income. On $282,900 of gain: $10,750.

Total federal tax on the sale: $38,750 plus $19,185 plus $10,750 equals $68,685.

That represents 24.3% of the gross gain. Sellers who estimate only the capital gains portion would have budgeted roughly $19,000 to $31,000 less than they actually owe.

Worked Example 2: Investor Who Never Tracked Depreciation

This situation is more common than tax professionals like to admit. Some investors, particularly those who self-managed their properties or used unsophisticated accounting, never claimed depreciation deductions.

The IRS does not forgive this error in the seller's favor. Under Treasury Regulation 1.1250-3, the IRS calculates recapture based on depreciation "allowed or allowable." If you failed to claim it, you still owe recapture tax as if you had.

Scenario: Investor owned a commercial property for 18 years.

• Original depreciable basis: $560,000
• Annual depreciation (39-year schedule): $14,359
• Allowable depreciation over 18 years: $258,462
• Actual depreciation claimed: $0

At sale, the IRS calculates gain using the full $258,462 of allowable depreciation, reducing the adjusted cost basis accordingly. The investor owes recapture tax on $258,462 while having received zero annual tax benefit from those deductions.

The lesson: claim depreciation every year, without exception. Failing to claim it costs you twice. You pay higher income taxes during ownership, and you still pay recapture tax at sale.

Section 1245 vs. Section 1250: When the Rate Changes

Most real property falls under Section 1250, which caps recapture at 25%. Personal property and certain other assets fall under Section 1245, which taxes recapture at ordinary income rates, potentially reaching 37% for high earners.

If you claimed bonus depreciation or Section 179 expensing on appliances, HVAC systems, or other personal property placed in service at the rental, those deductions recapture under Section 1245. The ordinary income rate applies to that portion.

A property with $30,000 in Section 179 deductions on appliances over its holding period generates $30,000 of Section 1245 recapture at the seller's ordinary income rate. At 37%, that equals $11,100 in additional tax versus the 25% Section 1250 rate, which would produce $7,500. The difference matters.

Cost segregation studies, which accelerate depreciation on building components, create the same exposure. Investors who used cost segregation to front-load depreciation deductions face significant Section 1245 recapture at sale.

State Tax on Top of Federal

Federal recapture tax is only part of the calculation. Most states with income taxes treat depreciation recapture as ordinary income at the state level.

California taxes recapture at rates up to 13.3%. New York taxes it at rates up to 10.9%. Even states with flat income tax rates of 4% to 5% add meaningfully to the total bill.

On the $155,000 of recaptured depreciation from Worked Example 1, a California investor pays an additional $20,615 in state tax. The combined federal and state bill on the recapture portion alone reaches $59,365, before accounting for capital gains tax on the remaining gain.

Plan around state taxes from the beginning of the hold period, not at the point of sale.

1031 Exchange as a Deferral Strategy

A Section 1031 like-kind exchange defers both capital gains tax and depreciation recapture by rolling the adjusted cost basis, including its accumulated depreciation reduction, into the replacement property.

The deferred recapture does not disappear. It accumulates. An investor who executes multiple 1031 exchanges over decades can build a deferred tax liability exceeding $500,000. At death, heirs receive a stepped-up basis under current law, eliminating the accumulated liability entirely.

That outcome is not guaranteed. Congress has proposed eliminating or limiting the step-up in basis repeatedly. Investors relying on this strategy should monitor legislative developments and maintain a current estimate of their deferred liability.

How to Run This Calculation Before You List

Sellers who calculate this number after accepting an offer often discover the deal makes less sense than anticipated. Run the numbers before you price the property.

The inputs are:

1. Net expected sale price after commissions and closing costs.
2. Original cost basis including improvements.
3. Accumulated depreciation from your tax returns, specifically Schedule E and Form 4562.
4. Your expected federal taxable income in the year of sale, inclusive of the gain.
5. Your state of residence and applicable state income tax rate.

With those five inputs, the CalcMoney Income Tax Calculator produces a federal tax estimate on your gain. Add your state rate manually to the recapture and capital gains amounts to reach a full picture.

The difference between a rough estimate and a precise calculation can reach $40,000 or more on a property held for a decade or longer. That difference affects negotiation strategy, whether a 1031 exchange makes sense, and how much you net after taxes.

You Might Also Like

• How to Calculate Rental Property Depreciation and Reduce Your Tax Bill
• How to Calculate the Exact Tax Savings From a 1031 Exchange
• How to Calculate 1099 Income After All the Taxes You Actually Owe

Run your numbers now with the CalcMoney Income Tax Calculator →