Depreciation Recapture on Rental Property: What Agents Should Tell Selling Landlords

A landlord who has owned a rental for years often expects to pay capital gains tax on the sale and is surprised by a second item: depreciation recapture. Raising it at the listing appointment, before the client sees a CPA’s estimate, makes you the agent who prepared them. This guide covers how recapture works, a worked example, and what each deferral option can do with it.

To split a client’s own sale into its parts, use the depreciation recapture calculator. This guide is part of our series for agents; the hub is OZ talking points for your next listing appointment.

What depreciation recapture is

A landlord deducts depreciation on the building every year (residential rental buildings over 27.5 years). Those deductions reduce the building’s basis. When the property sells, the gain is figured from that lower basis, and the part of the gain that comes from the depreciation is taxed differently:

• Unrecaptured §1250 gain: gain up to the straight-line depreciation on the building is taxed at no more than 25% federally (IRC §1(h)(1)(E) and (h)(6)).
• §1245 recapture: gain up to the depreciation on personal property, such as appliances, carpeting, or components separated out in a cost segregation study, is ordinary income (IRC §1245).
• The rest of the gain is usually long-term capital gain under §1231, taxed at 0%, 15% or 20%.
• The 3.8% net investment income tax can apply on top for higher-income sellers (IRC §1411).

Recapture applies to depreciation “allowed or allowable.” A landlord who never claimed it still has the lower basis (IRC §1016(a)(2)).

Depreciation recapture tax rate

There isn’t one depreciation recapture tax rate. The rate depends on what was depreciated and on the seller’s income:

So a landlord in a lower bracket pays less than 25% on the §1250 part, and a landlord in a top bracket pays 25% on it, plus the NIIT if it applies. State income tax is separate. The depreciation recapture calculator applies these rates to a client’s sale.

A worked example

An illustration with round numbers, ignoring selling costs and the mid-month convention:

At the top rates, the recapture part alone could carry about $36,364 of federal tax before the 3.8% NIIT. The CPA will have the real figures, but the shape is the same for most long-held rentals.

What each option does with recapture

The Opportunity Zone rule comes from Treas. Reg. §1.1400Z2(a)-1(b)(11)(iii) and (c)(1)(i). For investments made on or after January 1, 2027, the deferred gain is included after five years, less a 10% basis step-up (30% for a qualified rural fund), and appreciation on the fund can be excluded after 10 years. See the Opportunity Zone tax benefits guide and the 180-day deadline calculator.

To compare a 1031, a DST and an Opportunity Zone fund on the client’s numbers, use the 1031 vs DST vs Opportunity Zone calculator.

What to ask a selling landlord

• “Do you have your depreciation schedules from your returns?” Ask the CPA to pull them.
• “Did you ever do a cost segregation study?” That raises the §1245 part, which no deferral option except a 1031 can help with.
• “Do you want to own another rental?” If yes, a 1031 keeps the recapture deferred. If no, an Opportunity Zone fund can defer most of it, but not §1245 recapture.
• “Do you have suspended passive losses?” A full taxable sale generally frees them (IRC §469(g)), which can offset part of the gain.

Related reading

• Capital gains tax on rental property
• Can you 1031 into an Opportunity Zone?
• OZ talking points for agents (series hub)

Sources: IRC §1; IRC §1245; IRC §1250; IRC §1016; IRC §1411; IRC §1031; IRC §453; Treas. Reg. §1.453-12; IRC §121; IRC §469; Treas. Reg. §1.1400Z2(a)-1; IRS Publication 544.

Not tax advice.