Short answer
When you sell a rental property for more than its adjusted basis, the part of the gain equal to the depreciation you took (or could have taken) is taxed at up to 25%, and the rest at long-term capital gains rates. On an $850,000 sale with $110,000 of depreciation, recapture alone is up to $27,500.
1. Why depreciation matters at sale
Depreciation lets you deduct part of a rental building's cost each year. Residential rental property is depreciated over 27.5 years, and land is never depreciable. Every dollar of depreciation also lowers your basis, which raises your taxable gain when you sell. The IRS counts depreciation you were allowed to claim even if you did not claim it.
2. The formula
- Adjusted basis = purchase price + capital improvements − depreciation.
- Gain = sale price − selling costs − adjusted basis.
- Recapture portion = the lesser of the gain and the depreciation taken, taxed at up to 25% (unrecaptured section 1250 gain).
- Remainder is taxed at long-term capital gains rates (0%, 15% or 20%), plus 3.8% net investment income tax if your income is above the threshold, plus any state tax.
3. Worked example
You bought a rental for $400,000, added $50,000 of improvements and claimed $110,000 of depreciation. You sell for $850,000 with $55,250 of selling costs. Adjusted basis is $340,000 and the gain is $454,750.
| Piece of tax | Scenario A (15% federal, 5% state, no NIIT) | Scenario B (20% federal, 9.3% state, 3.8% NIIT) |
|---|---|---|
| Depreciation recapture (25% of $110,000) | $27,500 | $27,500 |
| Capital gains on $344,750 | $51,713 | $68,950 |
| Net investment income tax | $0 | $17,281 |
| State tax | $22,738 | $42,292 |
| Total | $101,950 | $156,022 |
The rates in the table are examples. The net investment income tax applies when modified adjusted gross income is over $200,000 (single) or $250,000 (married filing jointly), and your own rates depend on your income. Recapture is taxed at your ordinary rate up to the 25% cap.
4. Can you avoid it?
A 1031 exchange defers both the capital gains and the recapture if you reinvest all the net proceeds and replace the debt. The tax is not forgiven: it is built into the lower basis of the replacement property. See the 1031 deadlines and how a qualified intermediary works.
5. Frequently asked questions
What is depreciation recapture?expand_more
It is the tax on the part of your gain that comes from depreciation deductions on a rental property. For real estate it is taxed at ordinary rates up to a 25% maximum.
Do you pay depreciation recapture if you did not claim depreciation?expand_more
Yes. The IRS reduces basis by the depreciation you were allowed to claim, even if you did not claim it.
How do you avoid depreciation recapture on a rental property?expand_more
A 1031 exchange can defer it if you reinvest all net proceeds in like-kind real property and replace the debt. The deferred gain carries into the new property's basis.
Is depreciation recapture subject to the net investment income tax?expand_more
Gain from selling rental real estate is net investment income, so the 3.8% tax can apply if your modified adjusted gross income is above $200,000 for single filers or $250,000 for married filing jointly.