What Is Depreciation Recapture Tax

Every year a rental or commercial property is depreciated, the owner gets a deduction that lowers taxable income. Sell the property, and that benefit comes due: depreciation recapture is the tax on the portion of gain that corresponds to depreciation claimed during ownership, and it's calculated and taxed separately from the rest of the capital gain. Owners of long-held El Paso rentals are often the most surprised by how much of the final tax bill this piece represents.

The IRS treats depreciation as a benefit that was, in effect, borrowed against future tax, and recapture is how that benefit gets paid back at sale. For residential and commercial real property, the recaptured amount is taxed at a maximum federal rate of 25 percent, higher than the top long-term capital gains rate for most sellers, which is why it can't just be folded into the regular gain calculation.

Residential rental property depreciates over 27.5 years, commercial property over 39, using the building's value, not the land. An El Paso duplex bought for $220,000 with $180,000 allocated to the building depreciates roughly $6,500 a year. Held for twelve years, that's close to $78,000 in accumulated depreciation, all of it exposed to the 25 percent recapture rate at sale regardless of what happens to the rest of the gain.

A straightforward taxable sale triggers recapture in the year of the sale, added to whatever capital gains tax is owed on the rest of the appreciation. A 1031 exchange defers both pieces together, the capital gains and the depreciation recapture, carrying them forward into the replacement property's basis rather than triggering either as taxable income in the current year. There's no way to defer recapture on its own without also structuring the transaction as a qualifying exchange.

• Recapture applies to the portion of gain tied to depreciation actually claimed
• Taxed separately, at up to 25 percent federally, from the rest of the capital gain
• Triggered by a taxable sale, deferred along with capital gains by a 1031 exchange
• Applies whether or not the owner actually used the full available depreciation each year

Sellers who plan around the capital gains number alone and forget recapture often end up with a materially larger tax bill than expected, sometimes large enough to change whether a straightforward sale still makes financial sense compared to an exchange. Running both numbers, the capital gains exposure and the separate recapture exposure, before listing gives an accurate picture of what a straight sale actually nets versus what deferring both through an exchange would preserve. This is worth doing well before a listing goes live, since the answer can change whether an owner lists the property outright or lines up a qualified intermediary first. A CPA who's already reviewed the property's depreciation schedule can usually produce both numbers within a day or two, which is fast enough to inform the listing decision itself.