Depreciation Recapture on a sale with a Capital Loss

[Justin Bush]

Recently sold a property at a loss and wondering if depreciation recapture should be taking place? For rough numbers we purchased property for $1.65M and sold for $1.35M. Owned for 4 years and had about $225,000 in depreciation during that time. To me that’s a $330,000 loss but accountant telling me it’s $135,000 because depreciation gets added back in. The reason we’d like loss higher is because we sold another property for a large gain and would like to hedge as much loss against it to cut gains tax on that sale. Thanks in advance to all and much appreciate any and all help!

[Lauren Robins]

Hi Justin!

When you sell a property at a loss, the tax treatment can be counterintuitive due to how depreciation is handled. Even though you sold the property for $300,000 less than you paid for it ($1.65M purchase vs. $1.35M sale), for tax purposes, your loss is calculated against the adjusted basis, not the original purchase price. The adjusted basis is the original cost minus any depreciation taken—so in your case, $1.65M minus $225,000 equals an adjusted basis of $1.425M. Comparing that to the $1.35M sale price results in a taxable loss of only $75,000. Your accountant appears to be referencing a loss of $135,000, possibly adjusting for selling costs or other basis adjustments, but the key point is that depreciation reduces your basis and therefore reduces the size of your capital loss. Importantly, depreciation recapture only comes into play if you sold the property for more than your depreciated basis—i.e., at a gain. Since you sold below your adjusted basis, there is no depreciation recapture to pay. While this smaller loss is less helpful in offsetting gains from the other property sale, unfortunately, it aligns with tax rules under IRC §1011 and §1250.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, financial, or investment advice. No attorney-client, fiduciary, or professional relationship is established through this communication.