Real Estate Tax Calc
Yes: both apply, but on different slices
When you sell a rental at a gain, the IRS divides that gain into two buckets. The first — equal to total depreciation you claimed — is unrecaptured Section 1250 gain, taxed at up to 25%. The second — any remaining gain above the recapture amount — is long-term capital gain, taxed at 0%, 15%, or 20%. You pay both, but never at the same rate on the same dollar. The total federal tax is the sum of both components.
A worked example
Buy at $200,000, claim $50,000 depreciation over 10 years, sell at $350,000. Adjusted basis = $200,000 - $50,000 = $150,000. Total gain = $350,000 - $150,000 = $200,000. Recapture bucket: $50,000 taxed at 25% = $12,500. Capital gain bucket: $150,000 taxed at 15% = $22,500. Federal total: $35,000, or 17.5% effective rate on the gain. Adding the 3.8% NIIT (if applicable) and state tax could bring the total effective rate to 25-30%.
What if the gain is smaller than the depreciation?
If your total gain is less than or equal to the total depreciation you claimed, the entire gain is recapture — there is no separate capital gain component. Example: sell at $220,000 (basis $150,000) with $70,000 of depreciation. Total gain = $70,000, which equals only part of depreciation. Entire gain is recaptured at up to 25%. The remaining depreciation ($0 more) does not create additional tax because there is no gain to recapture it from.
Why recapture exists in the first place
Depreciation gave you an annual deduction against ordinary rental income — often taxed at rates up to 37% while you owned the property. Recapture is Congress's way of clawing back part of that benefit when you sell: rather than let you convert a stream of ordinary deductions into purely preferential capital gain, the tax code recaptures the depreciation portion at a higher rate than the 0/15/20% capital gains rates. For real property, this is unrecaptured Section 1250 gain, capped at a 25% federal rate. It is best understood as 'you got an ordinary-rate deduction going in, so you give some of it back at a higher-than-capital-gains rate coming out.' The rest of your appreciation still enjoys the favorable long-term capital gains rates.
The 'allowed or allowable' trap
A costly misconception is that skipping depreciation lets you avoid recapture. It does not. Section 1250 recaptures depreciation allowed or allowable — meaning the IRS reduces your basis (and computes recapture) based on the depreciation you could have claimed, whether or not you actually deducted it. A landlord who never depreciated the building still faces recapture as if they had, having wasted years of deductions for nothing. The fix is Form 3115 (Change in Accounting Method), which lets you claim the missed depreciation as a catch-up 'Section 481(a) adjustment' — recovering the deductions you skipped rather than losing them. Always depreciate; the recapture is coming either way.
How cost segregation splits recapture into 1245 and 1250
If you ran a cost segregation study, your recapture is no longer a single number. Components reclassified as Section 1245 personal property (appliances, carpeting, certain fixtures) and land improvements recapture differently from the building. Section 1245 recapture applies to the extent of depreciation on those components and is taxed at your ordinary income rate — not capped at 25% — up to the amount of gain attributable to them. The building shell remains Section 1250 property with the 25% cap. Because bonus depreciation front-loads write-offs on the 1245 components, a cost-seg property can carry a meaningful ordinary-rate recapture layer at sale. This does not erase the strategy's value — time value and rate arbitrage usually still win — but it means your sale has three tax layers (1245 ordinary recapture, 1250 25% recapture, and 0/15/20% capital gain), not two.
A larger worked example with NIIT and state tax
Buy at $400,000 (building $320,000), claim $120,000 of depreciation over 12 years, sell for $700,000 with $42,000 of selling costs. Amount realized = $658,000; adjusted basis = $400,000 - $120,000 = $280,000; total gain = $378,000. Recapture layer: $120,000 unrecaptured Section 1250 gain at 25% = $30,000. Capital-gain layer: $258,000 at 15% = $38,700. Federal income tax = $68,700. Now add the 3.8% NIIT on the $378,000 gain (assuming you are over the MAGI threshold) = $14,364, and a 5% state tax = $18,900. All-in: about $102,000, an effective rate near 27% on the gain. Notice the recapture layer alone — $30,000 — is what a 1031 exchange or a step-up in basis at death could defer or eliminate.
Reporting both on Form 4797
Both components are reported on Form 4797, Sales of Business Property. The gain calculation and the split between ordinary recapture and Section 1231 gain happen in Part III. Any Section 1245 ordinary recapture is pulled out there; the remaining Section 1231 gain flows to Schedule D and is treated as long-term capital gain, with the unrecaptured Section 1250 portion carried to the Unrecaptured Section 1250 Gain Worksheet so the 25% cap is applied. Tax software handles the mechanics, but you must feed it the correct depreciation total — every year's Schedule E depreciation, plus any cost-seg component schedules. An understated depreciation figure understates recapture and invites an IRS adjustment later.
How a 1031 exchange defers both layers
A properly structured 1031 exchange defers the entire gain — both the recapture and the capital-gain layers — by rolling it into the basis of the replacement property. You recognize tax only on 'boot' (cash or net debt relief you fail to reinvest). The deferred recapture and gain ride forward in the replacement's lower basis and resurface when you eventually sell without exchanging. Chain exchanges across a lifetime and hold until death, and the step-up in basis your heirs receive can wipe out the accumulated recapture and gain permanently — the 'swap till you drop' outcome. For an investor staying in real estate, this is the most complete answer to 'do I have to pay both?': not now, and possibly never.
State tax usually has no 25% cap
The 25% ceiling on unrecaptured Section 1250 gain is a federal rate cap — most states do not mirror it. The majority of states that tax income treat both your recapture and your capital gain as ordinary income at the state's regular rates, with no preferential capital-gains rate and no special cap on the recapture portion. So a seller in a high-tax state can face a state rate on the recapture slice that is higher than they expect after focusing on the federal 25% figure. A handful of states impose no income tax at all, which can make where you are a resident when you sell a meaningful planning variable, and some states tax nonresidents on real estate located there regardless of residency. When you estimate the combined bill, add your state's full ordinary rate on both layers rather than assuming the federal cap carries over — it usually does not.
Partial dispositions and prior improvements
Two situations complicate the clean two-bucket picture. First, if you made capital improvements over the years — a new roof, an addition, a renovation — each has its own depreciation history, and the depreciation claimed on those improvements is part of the total recapture at sale, not just the depreciation on the original building. Track every improvement's cost and accumulated depreciation so the recapture figure is complete and correct. Second, the partial disposition rules let you write off the remaining basis of a component you retire and replace (for example, the old roof when you install a new one), which accelerates a deduction while you own the property — but it also affects the basis and recapture math at ultimate sale, because you have already recovered part of that basis. If your property has a layered history of improvements and replacements, reconstruct the full depreciation ledger before computing gain; a missing improvement schedule is one of the most common sources of an incorrect recapture number.
Frequently asked questions
Are capital gains and depreciation recapture the same thing?
No — they are two distinct components of the same gain taxed at different rates. Recapture covers the depreciation-equivalent portion at up to 25%; capital gains cover the rest at 0/15/20%.
Do I always pay both?
Only when total gain exceeds total depreciation claimed. If the gain is less than depreciation, everything is recapture with no separate capital gain component.
Can I avoid recapture by not claiming depreciation?
No. Section 1250 recaptures depreciation 'allowed or allowable,' so the IRS taxes the depreciation you could have claimed whether or not you deducted it. Skipping depreciation wastes the deductions without avoiding recapture; Form 3115 can recover missed depreciation.
Is depreciation recapture always capped at 25%?
The unrecaptured Section 1250 gain on the building is capped at 25%. But Section 1245 recapture on cost-segregated components (appliances, fixtures, land improvements) is taxed at your ordinary rate, which can exceed 25% for high earners.
Which form reports the recapture and capital gain?
Form 4797. Part III computes the gain and separates ordinary Section 1245 recapture from Section 1231 gain, which then flows to Schedule D with the unrecaptured Section 1250 portion taxed at up to 25%.
Does my state also cap recapture at 25%?
Usually not. The 25% ceiling is a federal rate cap; most states tax both the recapture and the capital gain as ordinary income at their regular rates with no equivalent cap, so add your state's full rate on both layers when estimating the total tax.
How do capital improvements affect the recapture at sale?
Improvements add to your basis and reduce the gain, but the depreciation you claimed on those improvements is part of the total recapture. Track every improvement's cost and accumulated depreciation so the recapture figure is complete — a missing improvement schedule is a common source of an incorrect number.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.