Depreciation Recapture reminder

[E. James Jackson]

I recently helped a client who was selling a rental property, and depreciation recapture ended up being the hardest part for her to understand as we did her tax projection. It made me realize it might be helpful to break this down for others here.

As you know, when you own a rental, you’re allowed to deduct depreciation each year to reduce taxable income. That’s a real benefit while you own the property.

But when you sell, the IRS wants some of that benefit back, this is called depreciation recapture.

The IRS looks at the total depreciation you were allowed to take (not just what you actually claimed). That amount is “recaptured” and taxed separately from capital gains. For most residential rental real estate (1250 Property), recapture is taxed at up to 25%

Simplified examplefor example: 

• Buy rental for $300k

• Allocate $240k to the building

• Depreciate ~$8.7k/year over 27.5 years

• Sell after 5 years with ~$43k in depreciation

  That $43k is taxed as depreciation recapture when you sell

A lot of investors are surprised by this because they focus on the capital gain and don’t realize it’s two layers of tax, not one.

It doesn’t mean depreciation was a bad deal—it usually still helps a lot—but it does mean you should understand how it plays out upon disposition.

Hope this helps clarify things. Curious if others here factor recapture into their hold vs. sell decisions?