The setup
Purchase price: $320,000 (land: $64,000; building: $256,000). Capital improvements during ownership: $30,000. Years held: 10. Annual depreciation: $256,000 / 27.5 = $9,309/year; 10 years = $93,090 total claimed. Adjusted basis: $320,000 + $30,000 - $93,090 = $256,910. Net sale price (after selling costs): $500,000.
Breaking down the gain
Total gain: $500,000 - $256,910 = $243,090. This splits into two buckets. Recapture bucket (Section 1250): $93,090, taxed at up to 25% = up to $23,273 in federal tax. Long-term capital gain bucket: $243,090 - $93,090 = $150,000, taxed at 0%, 15%, or 20% depending on your income. At 15%: $22,500. Federal total (before NIIT and state tax): roughly $45,773.
Is claiming depreciation worth it?
The recapture owed ($23,273) often prompts investors to wonder whether taking depreciation was worthwhile. Consider: the $9,309 annual deduction saved approximately $2,048/year in federal tax (at a 22% rate) over 10 years, totaling $20,480. At higher brackets the savings are larger. Critically, IRS taxes recapture on depreciation 'allowed or allowable' — meaning you would owe the $23,273 even if you had never claimed the deductions. So skipping depreciation gives up the savings without eliminating the recapture. Always claim it.
Frequently asked questions
How do I calculate depreciation recapture on a rental sale?
Total gain = sale price minus adjusted basis. Recapture = the lesser of total gain or total depreciation claimed, taxed at up to 25%. Any remaining gain is long-term capital gain.
Does taking depreciation cause a bigger tax bill at sale?
Yes on recapture — but the annual tax savings from depreciation deductions over the hold period typically outweigh the recapture cost, especially for long holds and higher tax brackets.
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.