What adjusted basis is
Your adjusted basis is what you have 'invested' in the property for tax purposes. Start with your purchase price, add transaction costs (title fees, legal, recording fees), add the cost of capital improvements, then subtract all depreciation you have claimed over the years. Adjusted basis decreases every year you take depreciation — a $300,000 building depreciating at $10,909/year has an adjusted basis of $190,909 after 10 years.
Why lower basis means a bigger gain
Taxable gain equals sale price minus adjusted basis. If your basis has dropped by $110,000 over 10 years of depreciation, your gain on sale is $110,000 higher than it would be if you had never depreciated. That extra $110,000 of gain is exactly the recapture amount — it is the tax math working in reverse. Depreciation saves you money each year and costs you at sale; basis is the bridge between those two events.
The 'allowed or allowable' trap
The IRS reduces your basis by depreciation 'allowed or allowable' — meaning what you could have deducted, whether or not you actually claimed it. If you skipped depreciation for several years thinking you would avoid recapture, the IRS still reduces your basis and taxes you on the missed deductions at sale. This is why qualified advisors universally recommend claiming every depreciation dollar you are entitled to: you will owe the recapture either way, so you might as well take the deductions.
Frequently asked questions
Why does depreciation increase my gain when I sell?
Depreciation reduces your adjusted basis, which increases the taxable gain at sale. The portion equal to depreciation claimed is recaptured at up to 25%. The annual savings typically outweigh this cost.
What if I never claimed depreciation — do I still owe recapture?
Yes. The IRS taxes recapture on depreciation allowed or allowable, so you owe it on what you could have taken even if you didn't. You gave up the deduction but kept the recapture liability.
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.