Definition
Depreciation recapture is the portion of the gain on a sold asset that is attributable to the depreciation deductions previously claimed against it. Because depreciation reduced the owner’s taxable income over the holding period and lowered the asset’s basis, the tax code “recaptures” that benefit at sale — often taxing it at a rate different from ordinary long-term capital gains. For real estate, this typically appears as unrecaptured §1250 gain, while §1245 governs certain other property.
How Depreciation Recapture Works
Recapture ties the tax at sale back to deductions taken during ownership:
- Basis reduction. Depreciation lowers the asset’s adjusted basis each year, which increases the gain recognized on a later sale.
- Unrecaptured §1250 gain. For real property, the depreciation component is generally taxed at a maximum federal rate of 25%, above the long-term capital gains rate.
- Remaining gain. Gain in excess of prior depreciation is typically taxed as long-term capital gain.
- Section 1245. Certain non-real-property assets can be subject to ordinary-income recapture rules.
Tax Treatment and Deferral Options
Recapture is a common surprise for real estate investors, because it can apply even when the headline “capital gains rate” seems favorable. A 1031 exchange can defer both the capital gain and the depreciation recapture by carrying them into the replacement property’s basis. Separately, a step-up in basis at death may eliminate built-in gain and recapture for heirs. Strategies like cost segregation accelerate depreciation, which can increase the recapture exposure later — a trade-off worth understanding.
Key Characteristics
| Feature | Depreciation Recapture |
|---|---|
| Authority | IRC §1250 / §1245 |
| Real estate rate | Up to 25% (unrecaptured §1250 gain) |
| Trigger | Sale of a depreciated asset |
| Deferral | Possible via 1031 exchange |
| Potential elimination | Step-up in basis at death |
| Interaction | Larger with accelerated depreciation |
Important Considerations
Depreciation recapture can meaningfully raise the tax due on a sale, and it is easy to underestimate when planning around the capital gains rate alone. Strategies that accelerate depreciation increase near-term deductions but can enlarge recapture on exit. Deferral through a 1031 exchange or elimination via a step-up depends on strict rules and facts that vary by taxpayer. Real estate itself carries market, tenant, and financing risk, including possible loss of principal. Confirm your specific recapture exposure with your CPA.
Related Terms
- 1031 Exchange — can defer recapture into replacement property
- Step-Up in Basis — can eliminate recapture for heirs
- Cost Segregation — accelerates depreciation, affecting recapture
This definition is educational only and is not investment, tax, or legal advice. Depreciation recapture rates and rules are set by the tax code and depend on your facts, and real estate investments carry risk including possible loss of principal. Confirm current rules and your specific treatment with your CPA.
Planning Around a Property Sale?
Discuss how depreciation recapture and deferral strategies work with a qualified advisor.