Depreciation Recapture When Selling to Family

Recapture still applies at actual sale price

Depreciation recapture is calculated on your gain — the difference between your adjusted basis and the actual sale price. Selling to a family member at a discount reduces your realized gain but doesn't eliminate the recapture component. If your adjusted basis is $150,000 and you sell to a sibling for $200,000, you have a $50,000 gain; if depreciation claimed was $50,000, that entire $50,000 is recaptured at up to 25%.

The bargain-sale / deemed-gift problem

When you sell below fair market value to a related person, the IRS may treat the discount as a part gift. If the property is worth $350,000 and you sell for $200,000, the $150,000 discount could be a reportable gift on Form 709. The buyer's basis is generally the greater of what they paid or your adjusted basis, which can limit their future loss deductions on a quick resale.

Section 267: losses disallowed between related parties

If the discounted sale produces a loss for you, Section 267 disallows that loss between related parties (siblings, parents, children, spouses, and certain entity relationships). Gains, however, remain fully taxable. This asymmetry means family sales at a discount rarely achieve the tax goal investors hope for, while introducing new complexity.

Who counts as a 'related party'

The tax code defines related parties broadly, and the definition varies slightly by provision. For the Section 267 loss-disallowance rules, related parties include your spouse, siblings, ancestors (parents, grandparents), and lineal descendants (children, grandchildren), plus a range of controlled entities — corporations, partnerships, trusts, and estates in which you or your family hold a controlling interest. Notably, in-laws, aunts, uncles, cousins, and ex-spouses are generally not related for Section 267 purposes. For 1031 exchanges, Section 1031(f) uses its own related-party definition. Because the lists differ, confirm the specific relationship against the specific provision before assuming a transaction is or isn't caught.

How the bargain sale splits into sale and gift

A below-market sale to a relative is treated as part sale, part gift. The 'sale' portion equals what the buyer actually pays; the 'gift' portion equals the excess of fair market value over that price. On the sale portion, you compute gain the normal way — amount realized minus adjusted basis — and recapture applies to the depreciation-related slice. On the gift portion, you may owe gift tax reporting. Example: FMV $350,000, sale price $200,000, adjusted basis $150,000. You realize a $50,000 gain (fully taxable, recapture first), and you have made a $150,000 gift that must be measured against your annual exclusion and lifetime exemption.

Gift tax: annual exclusion and lifetime exemption

A gift above the annual exclusion (roughly $18,000–$19,000 per recipient in recent years, indexed for inflation) must be reported on Form 709. Reporting a gift rarely means writing a check, though: gifts above the annual exclusion simply reduce your lifetime gift-and-estate tax exemption, which sits in the multi-millions per person (about $13.99 million in 2025, also indexed). Most families never actually pay gift tax — they just file the return and draw down the lifetime exemption. But the reporting is mandatory, the exemption amount is scheduled to change under sunset provisions, and married couples can elect to 'split' gifts to double the annual exclusion. Confirm the current-year figures before filing.

The buyer's basis — and the dual-basis trap

When part of the transfer is a gift, your relative's basis is governed by the gift basis rules, which can create a dual basis. For computing a future gain, the buyer generally takes the greater of the price paid or your adjusted (carryover) basis, increased by any gift tax paid on appreciation. For computing a future loss, the basis cannot exceed the property's fair market value at the time of the gift. This dual-basis rule can leave a range in which the relative recognizes neither gain nor loss on a later sale. It also means the discount you 'gave' does not translate into a stepped-up basis — the recipient inherits your low basis and, with it, your built-in gain and future recapture exposure.

Installment sales to family: the Section 453(e) trap

Families often structure a sale as an installment sale so the seller reports gain as payments arrive. But Section 453(e) contains an anti-abuse rule: if a related-party buyer resells the property within two years, the original seller must generally accelerate and recognize the remaining deferred gain immediately, as if they had received the proceeds. This prevents families from using a related intermediary to convert an installment sale into an immediate cash-out at deferred rates. Genuine long-term family transfers are fine; quick related-party flips defeat the deferral.

A 1031 exchange with a relative has its own 2-year rule

If instead of selling you try to 1031 exchange with a related party, Section 1031(f) imposes a two-year holding requirement: if either party disposes of the exchanged property within two years, the deferral is generally undone and the gain (including recapture) becomes taxable. The rule targets 'basis shifting' where relatives swap high-basis and low-basis properties to cash out the low-basis one at a lower tax cost. Related-party exchanges are possible but require care and, usually, a two-year hold on both sides.

Worked example and the better alternatives

Put it together: you sell a rental to your daughter for $200,000 (FMV $350,000, adjusted basis $150,000, depreciation claimed $50,000). You recognize a $50,000 gain — the full $50,000 is recapture taxed up to 25% (about $12,500 federal), plus any state tax. You file Form 709 reporting a $150,000 gift, reducing your lifetime exemption; no gift tax is due. Your daughter takes a carryover basis around $150,000, keeping your built-in gain. If the goal was to help family and minimize tax, consider the alternatives: gifting outright (no recapture now, but recapture and low basis pass to the recipient), holding until death so heirs get a stepped-up basis that erases the built-in gain and recapture entirely, or a market-rate sale paired with a 1031 exchange to defer. Each has very different tax outcomes — model them side by side with a CPA before choosing.

Gift now vs. inherit later — the basis question

The central estate-planning trade-off is carryover basis vs. stepped-up basis. If you gift or sell the rental to family during your life, they take your low adjusted basis (carryover), inheriting all of your built-in gain and depreciation recapture — so when they eventually sell, they pay the tax you deferred. If instead you hold the property until death and it passes through your estate, your heirs generally receive a basis stepped up to fair market value on the date of death, which erases the built-in gain and the accumulated depreciation recapture. For a property with a large amount of prior depreciation, the step-up can be worth far more than any benefit of an early below-market sale. Weigh this against estate-tax exposure and the family's need for the asset now.

Documenting fair market value

Because a below-market family sale is measured against fair market value, you need defensible support for that value — the discount (and therefore the gift) is computed from it. A qualified appraisal at or near the transaction date is the gold standard; a broker's price opinion or comparable-sales analysis is weaker but better than nothing. If the IRS later argues the true FMV was higher than you claimed, the gift portion grows, potentially requiring a corrected Form 709 and using more of your lifetime exemption. Keep the appraisal, the sale contract, and your basis schedule together in the file. Under-documenting value is a common way an otherwise reasonable family transfer turns into an audit headache years later.

Don't overlook state and local transfer taxes

Federal income and gift tax are not the only costs. Many states and localities impose real estate transfer taxes (also called deed, documentary-stamp, or conveyance taxes) on the transfer of title, and some assess them on the full fair market value even in a bargain or gift transaction rather than only on the cash paid. A few jurisdictions offer exemptions for transfers between close family members — but you generally have to claim the exemption correctly at recording. Separately, a change in ownership can trigger a property-tax reassessment in some states, potentially raising the annual property-tax bill for the new owner (again, with intra-family exclusions available in certain states if properly filed). Check the local rules before transferring title.

Watch the assumed-mortgage boot

If your family buyer assumes an existing mortgage or takes the property subject to your loan, that debt relief is treated as an amount realized — as if you received cash equal to the loan balance. This can increase your taxable gain (and the recapture within it) beyond the actual cash changing hands, and in a part-gift transaction it complicates the split between the sale and gift portions. Say you sell to your son for $50,000 cash but he also assumes a $120,000 mortgage: your amount realized is $170,000, not $50,000, and the gain (recapture first) is computed against that larger figure. Owners who focus only on the cash price are frequently surprised by the tax bill that debt relief creates.

Frequently asked questions

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.

Related

• Depreciation Recapture Calculator
• How to Avoid Depreciation Recapture
• Depreciation Recapture on Gifted Property