What depreciation recapture is
The tax code lets owners of residential rental property deduct the cost of the building — not the land — over 27.5 years. Those deductions reduce your adjusted basis. When you sell, the gain is measured from that lower basis, so the depreciation you claimed shows up again as part of the profit.
For apartment buildings depreciated on the straight-line method, the portion of gain equal to the depreciation taken is generally called unrecaptured Section 1250 gain. It is taxed federally at your ordinary income rate, capped at 25%, rather than at the lower long-term capital gains rates that apply to the rest of the gain. Many owners also owe the 3.8% net investment income tax and state income tax on it.
How the calculator estimates it
If you know exactly how much depreciation you have claimed, enter it and the calculator uses your number. If not, it estimates the figure:
- Depreciable basis is the purchase price minus the land share, plus capital improvements.
- Annual depreciation is the depreciable basis divided by 27.5 years, the recovery period for residential rental property.
- Depreciation taken is the annual amount multiplied by the years you have owned the building, capped at the depreciable basis.
- Gain is the sale price minus selling costs minus adjusted basis (purchase price plus improvements minus depreciation).
- Recaptured gain is the smaller of total gain and depreciation taken. It is taxed at the lower of your ordinary rate and 25%, and the remaining gain is shown separately.
A worked example
An investor bought a building for $1,800,000, with 20% of the price allocated to land, and later spent $250,000 on improvements. The depreciable basis is $1,690,000, which works out to about $61,450 of depreciation a year. After eight years, they have taken roughly $491,600.
They sell for $3,200,000 with $120,000 of selling costs. The adjusted basis is about $1,558,400, so the total gain is about $1,521,600. Of that, $491,600 is recaptured. In the 32% bracket the recapture rate is capped at 25%, so the federal tax on that portion is about $122,900 before any surtax or state tax. The remaining $1,030,000 is taxed at long-term capital gains rates.
“Allowed or allowable” — why skipping depreciation does not help
Some owners assume that if they never claimed depreciation, there is nothing to recapture. The rule works the other way: basis is reduced by the depreciation you were entitled to take, whether or not you actually took it. Skipping the deduction gives up the annual tax savings and still leaves you with recapture at sale. If you discover missed depreciation, a CPA can usually correct it with an accounting-method change rather than amending years of returns.
Ways owners manage recapture
Recapture is part of the cost of owning rental property, but its timing can be planned.
- A 1031 exchange defers recapture along with the rest of the gain when you reinvest in like-kind property.
- An installment sale through seller financing can spread recognition of gain, although recapture amounts are often reported in the year of sale — check this with your CPA.
- Holding until death generally gives heirs a stepped-up basis, which can eliminate the built-in gain, including past depreciation.
- Selling in a lower-income year can reduce the rate applied to the recaptured portion if your ordinary rate falls below 25%.
What this estimate leaves out
The calculator assumes straight-line depreciation over 27.5 years with improvements depreciated as if placed in service at purchase. If you did a cost segregation study, some of the property was depreciated over 5, 7 or 15 years, and gain on those components is generally recaptured at ordinary income rates under Section 1245 rather than at the 25% cap. Mid-month conventions, partial years, suspended passive losses and state rules also change the result. Your depreciation schedule and a CPA will give you the real number.
