Depreciation Recapture on a Rental Property Sale: What to Expect

The catch when you sell

Every year you owned the rental, depreciation reduced your taxable income and your adjusted basis. At sale, that lower basis means a larger taxable gain — and the part of the gain equal to depreciation you claimed is taxed as unrecaptured Section 1250 gain at up to 25%.

A quick example

Buy at $300,000, claim $50,000 depreciation, sell at $400,000. Adjusted basis is $250,000, total gain $150,000. The first $50,000 is recaptured at 25% ($12,500); the remaining $100,000 is a long-term capital gain (at 15%, $15,000). Total: $27,500. Run your own numbers in the calculator below.

You owe it even if you skipped depreciation

The IRS taxes recapture on depreciation "allowed or allowable" — meaning you owe it on what you could have deducted, whether you claimed it or not. So there's no benefit to skipping depreciation.

Where recapture is reported: Form 4797 and the Schedule D worksheet

A rental building is Section 1250 property, and its sale is reported on Form 4797, Sales of Business Property. The gain flows through Part III of Form 4797, and the depreciation-driven portion is carried to the Unrecaptured Section 1250 Gain Worksheet found in the Schedule D instructions. That worksheet is what actually applies the maximum 25% rate to your depreciation. Your net capital gain then lands on Schedule D and flows to Form 1040. Understanding this trail matters, because a rental sale is not a single 'capital gain' line — it is split and taxed in two lanes across two different forms, and tax software that treats it as an ordinary stock sale will get it wrong.

Why it is called 'unrecaptured' Section 1250 gain

True Section 1250 recapture only applies to depreciation taken in excess of straight-line. Because residential rental real estate has been required to use straight-line depreciation for decades (27.5-year MACRS for residential, 39-year for commercial), there is usually no excess to recapture as ordinary income. Instead, the depreciation you claimed is labeled unrecaptured Section 1250 gain and taxed at a maximum of 25%. The distinction sounds academic, but it explains why the building's depreciation is capped at 25% rather than taxed at your full ordinary rate the way equipment and certain fixtures (Section 1245 property from a cost segregation study) can be.

The 25% figure is a ceiling, not a flat tax

Unrecaptured Section 1250 gain is taxed at your ordinary income rate, but capped at 25%. If your marginal rate in the year of sale is 22%, that recapture is taxed at 22%, not 25%. Only taxpayers whose ordinary rate would otherwise exceed 25% actually hit the cap. This is why the year you sell — and your other income that year — changes the bill. Selling in a lower-income year (after retirement, during a sabbatical, or in a year with large offsetting losses) can pull the effective recapture rate below the 25% headline number.

A fuller worked example with closing costs

Suppose you bought a duplex for $320,000 with $60,000 allocated to land, leaving $260,000 depreciable. You later spent $25,000 on a new roof (a capital improvement that adds to basis) and claimed $70,000 of depreciation over the years. Your adjusted basis = $320,000 + $25,000 − $70,000 = $275,000. You sell for $500,000 and pay $35,000 in selling costs (agent commission, title, transfer tax), so your amount realized = $465,000. Total gain = $465,000 − $275,000 = $190,000. Of that, $70,000 is unrecaptured Section 1250 gain (up to 25% = up to $17,500) and the remaining $120,000 is long-term capital gain (at 15% = $18,000). Federal total ≈ $35,500 before NIIT and state tax. Notice that both the improvement and the selling costs reduced the gain — keep every receipt.

NIIT and state tax stack on top

The 3.8% Net Investment Income Tax applies to net investment gains for taxpayers above the modified-AGI thresholds ($200,000 single / $250,000 married filing jointly, which are not indexed for inflation). It applies to both the recapture and the capital-gain portions. On top of that, most states tax the entire gain as ordinary income with no 25% cap and no preferential capital-gains rate. A realistic all-in rate for a high earner in a high-tax state can approach 35–40% on the recapture portion once NIIT and state tax are layered on — far above the 25% many sellers budget for.

Ways to reduce or defer the recapture

A 1031 like-kind exchange defers both the capital gain and the recapture into a qualifying replacement property. An installment sale (Form 6252) spreads the capital-gain portion over the years you collect payments — but note that unrecaptured Section 1250 gain is generally reported and taxed to the extent of gain recognized as payments come in, and any true Section 1245 ordinary recapture is taxed in full in the year of sale regardless of when you are paid. Holding until death gives heirs a step-up in basis that wipes out both the gain and the recapture. Timing the sale for a lower-income year, or freeing up suspended passive losses that release on a fully taxable disposition, can also cut the bill.

Common mistakes sellers make

Three errors recur: (1) forgetting that capital improvements add to basis and reduce the gain — undocumented improvements become lost deductions; (2) assuming depreciation only counts if it was actually claimed — the 'allowed or allowable' rule taxes it either way; and (3) budgeting only for the 15% capital-gains rate and being surprised by the separate 25% recapture lane plus NIIT and state tax. Estimate the full stack before you list, so the tax bill does not quietly consume a down payment you have already earmarked for your next property.

How cost segregation changes the recapture picture

If you ran a cost segregation study, you split the building into 5-, 7-, and 15-year components (carpeting, appliances, cabinetry, land improvements) that are Section 1245 property, plus the 27.5- or 39-year real property that is Section 1250. That matters at sale because Section 1245 recapture is ordinary income at your full marginal rate — not capped at 25% — up to the depreciation taken on those components. The accelerated deductions you enjoyed in early years therefore come back partly at ordinary rates. This does not make cost segregation a bad idea (the time value of money usually still favors it), but it means the 'up to 25%' shorthand understates the recapture on a property that was cost-segregated. Model both buckets separately when you plan the sale.

Selling at a partial gain or a loss

Recapture applies only to gain, and only up to the depreciation you claimed. If you sell for exactly your adjusted basis, there is no gain and no recapture. If you sell for less than adjusted basis, you have a loss — reported on Form 4797, where losses on business-use property are generally ordinary (not capital) and can offset other income without the $3,000 capital-loss limit. And if your gain is smaller than your total depreciation, the recapture is limited to the actual gain: you cannot be taxed on more recapture than you profited. These nuances make it worth computing the real number rather than assuming the worst case.

Prior 1031 exchanges carry deferred recapture forward

If the property you are selling was itself acquired through a 1031 exchange, the depreciation and deferred gain from the relinquished property carried into this one's basis. That means your recapture at this final sale can reflect depreciation stretching back across multiple properties, not just the years you held the current one. Investors who have chained several exchanges together are sometimes shocked at the size of the recapture when they finally cash out — which is exactly why the 'swap till you drop' strategy (holding until death for a step-up) exists. Know your full deferred history before you assume this sale is a clean slate.

Estimating your recapture before you list

A quick pre-listing estimate takes three inputs: your total depreciation claimed or allowable, your adjusted basis, and a realistic net sale price after selling costs. Compute total gain, cap the recapture bucket at the lesser of depreciation or total gain, tax that bucket at up to 25% (or your ordinary rate if lower, plus ordinary rates on any Section 1245 components), and tax the remaining gain at your long-term capital-gains rate — then layer NIIT and state tax. Doing this early tells you whether a 1031 exchange, an installment sale, or simply timing the sale into a lower-income year is worth pursuing. The calculator below runs the same math for you.

Frequently asked questions

How much is depreciation recapture when selling a rental?

The depreciation you claimed is taxed at up to 25%; gain above that is taxed at your long-term capital gains rate.

Can I avoid it when selling?

You can defer it with a 1031 exchange or eliminate it via a step-up in basis at death. See our guide on avoiding recapture.

What if I sell at a loss?

No gain means no recapture — recapture only applies to gain, up to the depreciation claimed.

Is depreciation recapture taxed as ordinary income?

For residential rental real estate depreciated straight-line, the depreciation portion is 'unrecaptured Section 1250 gain,' taxed at your ordinary rate but capped at 25% — not your full ordinary rate. Equipment and certain personal-property components (Section 1245) can instead be recaptured fully as ordinary income.

What form reports depreciation recapture on a rental sale?

Form 4797 (Sales of Business Property), with the depreciation portion carried to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, and the result flowing to Schedule D and Form 1040.

Does a 1031 exchange eliminate recapture or just defer it?

It defers it. The deferred recapture carries into the replacement property's basis and comes due when you eventually sell without another exchange — unless you hold until death and heirs receive a stepped-up basis.

Is recapture on a cost-segregated property still capped at 25%?

Only for the Section 1250 building portion. The 5-, 7-, and 15-year components a cost segregation study carves out are Section 1245 property, and their depreciation is recaptured as ordinary income at your full marginal rate — so budget separately for both buckets.

Sources

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.

Depreciation Recapture on a Rental Property Sale