Real Estate Tax Calc
They come from one gain
When you sell a rental at a profit, the IRS divides the gain into two buckets: the part equal to depreciation you claimed (recapture) and everything above it (capital gain).
Different rates
The recapture portion is unrecaptured Section 1250 gain, taxed at up to 25%. The remaining capital gain is taxed at 0%, 15%, or 20% depending on your income — usually lower.
Why it matters
Because recapture is taxed higher, the more depreciation you claimed, the larger the higher-taxed slice. Deferring with a 1031 exchange postpones both.
A worked example that splits the gain
Numbers make the split concrete. Say you bought a residential rental for $275,000, allocating $55,000 to land (never depreciable) and $220,000 to the building. Over 27.5-year straight-line depreciation, that's about $8,000 a year. After holding it 10 years you've claimed roughly $80,000 of depreciation, so your adjusted basis is $275,000 − $80,000 = $195,000.
You sell for $400,000 and pay $28,000 in closing costs, leaving an amount realized of $372,000. Your total gain is $372,000 − $195,000 = $177,000. The IRS splits it: the first $80,000 (equal to depreciation claimed) is unrecaptured Section 1250 gain taxed at up to 25%, and the remaining $97,000 is long-term capital gain taxed at 0/15/20%.
At a 24% ordinary bracket, the $80,000 recapture slice is taxed at 24% (below the 25% cap) for about $19,200; the $97,000 capital-gain slice at 15% adds about $14,550. That's roughly $33,750 of federal tax on the sale before any state tax or the 3.8% surtax — and it would have been lower if depreciation hadn't shifted a chunk of the gain into the higher-taxed bucket.
Why the recapture slice is taxed higher
Depreciation lowered your ordinary income each year you owned the property. When you sell, Congress "recaptures" that benefit rather than letting it convert permanently into lower-taxed capital gain. For real property (Section 1250), the recapture rate is capped at 25% instead of your full ordinary rate — a compromise. For personal property and cost-segregated components (Section 1245), recapture is taxed at full ordinary rates, which can exceed 25%.
In short, the recapture slice is the government reclaiming a portion of a deduction you already used to shelter ordinary income; the capital-gain slice is your true economic appreciation, which enjoys the preferential long-term rate if you held the property more than a year.
How each slice is reported on your return
The mechanics run through Form 4797 (Sales of Business Property). Gain on real property held over a year generally flows from Part III (Section 1250 property) to Part I, and the net long-term amount lands on Schedule D. The recapture portion doesn't get its own line with a 25% rate stamped on it — instead, you compute it on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, and the tax is figured on the Schedule D Tax Worksheet, which applies the 25% ceiling and the 0/15/20% brackets to the correct slices.
If you used cost segregation or ever deducted Section 1245 personal property (appliances, carpeting, certain fixtures), that recapture is computed in Part III of Form 4797 as ordinary income and generally taxed before you get to the 1250 layer.
Where NIIT and state tax change the picture
Two additions routinely push the real cost above the headline rates. The 3.8% Net Investment Income Tax applies to the entire gain — both slices — once your modified AGI crosses $200,000 (single) or $250,000 (married filing jointly). A large sale often spikes your income into that zone in the year of sale.
Most states tax the gain as ordinary income with no special 25% cap and no preferential capital-gain rate, so in a high-tax state your combined rate on both slices can climb well past the federal figures. Always model federal, NIIT, and state together — the 25% cap is only a federal ceiling on one slice.
Deferring or eliminating the split
A 1031 like-kind exchange defers both the recapture and the capital-gain slice, rolling your low basis into the replacement property. It postpones tax; it doesn't erase it. An installment sale (Form 6252) can spread the capital-gain slice across the years you collect payments, but note that Section 1245 ordinary recapture must be recognized in full in the year of sale regardless of when you're paid.
The most complete escape is the step-up in basis at death: if you hold until you die, your heirs take the property at fair-market value, and the deferred recapture and capital gain can disappear entirely — the "swap till you drop" endgame.
Common mistakes that enlarge the recapture slice
Assuming recapture is capped at your bracket, not 25%: the 25% is a ceiling, but the recapture slice is taxed at your ordinary rate up to 25% — many sellers in the 32%+ brackets forget the cap protects them, while those in the 12% bracket forget they pay only 12% on that slice.
Forgetting cost-seg 1245 recapture: accelerating depreciation feels free until sale, when reclassified components come back at ordinary rates. Ignoring 'allowed or allowable': even if you skipped depreciation, the IRS reduces your basis as if you took it, so you owe recapture on depreciation you never actually deducted. Claim it every year — skipping it is a pure loss.
Holding period only affects the capital-gain slice
The one-year holding period line matters for the appreciation, not the recapture. If you sell within a year of buying, the appreciation is a short-term capital gain taxed at ordinary rates — no 0/15/20% preferential treatment. Hold longer than a year and it's long-term. Depreciation recapture, by contrast, doesn't depend on a one-year test the same way; it's tied to depreciation you actually claimed, and on real property held long enough to depreciate, it lands in the unrecaptured Section 1250 bucket. Practically, almost every rental sale is a long-term event, but a quick flip converts the appreciation slice to ordinary rates and removes the capital-gain advantage entirely.
How the slices stack in the tax computation
The two slices aren't taxed in isolation — they stack on top of your ordinary income. Your wages and other ordinary income fill the brackets first; then unrecaptured Section 1250 gain and long-term capital gain sit on top. This ordering is why a big sale can push part of your capital-gain slice from the 15% bracket into the 20% bracket, and why the same sale can trigger the 3.8% NIIT once total income crosses the threshold. The Schedule D Tax Worksheet handles the stacking automatically, but the takeaway for planning is simple: a large gain in a high-income year is taxed harder than the same gain in a low-income year.
Capital losses can offset the capital-gain slice
Because unrecaptured Section 1250 gain is technically a category of long-term capital gain, capital losses you realize — from selling stocks, another property, or other investments at a loss — can offset your net capital gain, including the recapture and appreciation slices, when netted on Schedule D. Section 1245 ordinary recapture is different: it's ordinary income, so a capital loss won't directly cancel it. Harvesting investment losses in the same year as a property sale is a legitimate way to shrink the taxable capital-gain portion, though it won't help against the ordinary-income 1245 slice.
Planning tips to manage the split
Time the sale to a lower-income year — retirement, a sabbatical, or a low-earnings year can drop your capital-gain rate from 20% to 15% (or 15% to 0% on modest gains) and keep you under the NIIT threshold. Consider an installment sale to spread the appreciation across years and stay in lower brackets. Use a 1031 exchange if you want to keep investing and defer both slices. Harvest capital losses in the sale year. And keep clean depreciation records so the recapture slice is calculated on the true figure, not an inflated estimate. Model your specific numbers before listing — the difference between good and careless timing on a large sale is frequently five figures.
Why the distinction ultimately matters for cash flow
Understanding the split isn't academic — it changes how much cash you walk away with. Two investors with identical sale prices can owe very different taxes depending on how much depreciation each claimed, whether any of it was accelerated into Section 1245 property, and what tax bracket the sale lands them in. Before you sell, build a simple estimate: separate the depreciation slice (up to 25%) from the appreciation slice (0/15/20%), add the 3.8% NIIT and your state's rate, and subtract selling costs. That single exercise tells you your true net proceeds and often reveals that a 1031 exchange, an installment sale, or simply timing the sale to a lower-income year would keep meaningfully more money in your pocket.
Frequently asked questions
Is depreciation recapture the same as capital gains?
No. Recapture (up to 25%) covers the depreciation portion; capital gains (0/15/20%) covers the rest of the profit.
Which is taxed more?
Usually recapture, at up to 25%, versus 0–20% for long-term capital gains.
How do I figure out how much of my gain is recapture?
The recapture slice equals the depreciation you claimed (or could have claimed) — 'allowed or allowable.' Everything above that, up to your total gain, is capital gain. The Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions walks through it.
Does a 1031 exchange erase the recapture, or just delay it?
It defers both the recapture and the capital-gain portions into the replacement property's lower basis. The tax comes due if you later sell without exchanging again — unless a step-up in basis at death eliminates it.
What forms report the two slices?
Form 4797 handles the sale of business/rental property and feeds Schedule D; the 25% recapture rate and 0/15/20% capital-gain rates are applied via the Unrecaptured Section 1250 Gain Worksheet and the Schedule D Tax Worksheet.
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.