Topic 07 · 6 min read
Recapture: Settling Up at Sale
The deductions come back to the table when you sell.
Depreciation lowered your taxable income while you owned the property, and it also lowered your adjusted basis, which makes the gain at sale larger. The portion of the gain caused by depreciation is taxed under its own rules — at up to 25 percent for real estate — rather than at the lower long-term capital gain rates.
What to know
- Two layers of gain
- The part of the profit equal to depreciation claimed is taxed first at recapture rates; the rest is ordinary long-term capital gain.
- Allowed or allowable
- Recapture is measured by the depreciation you could have claimed, so failing to claim it does not avoid it.
- Components recapture harder
- Short-life property carved out by a cost segregation study can recapture at ordinary income rates, not the 25 percent ceiling.
- Deferral, not escape
- A 1031 exchange postpones recapture along with the gain; a step-up at death can end it entirely.
The tax benefit
Even with recapture, the deduction was taken at your ordinary rate today and repaid at a capped rate later — often a favorable trade, and one that can be deferred indefinitely.
Worked example
Unwinding the numbers
A property bought for $406,000, with $90,000 of depreciation claimed, has an adjusted basis of $316,000. Selling at $500,000 produces $184,000 of gain: $90,000 taxed as recapture and $94,000 as long-term capital gain.
Watch out for
- Selling costs reduce the amount realized, so they shrink the gain.
- State tax may apply to the full gain regardless of federal treatment.
- A large sale can push other income into higher brackets and surtaxes.
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