Depreciation Recapture

Depreciation is a loan from the IRS, not a gift. Each year a rental owner deducts a slice of the building’s cost (over 27.5 years for residential property), and each deduction lowers the property’s adjusted basis. At sale, the gain is measured against that lowered basis, so the deducted dollars come back as gain, and the portion attributable to straight-line depreciation on real property, called unrecaptured Section 1250 gain, is taxed at ordinary rates capped at 25 percent instead of the gentler 15 or 20 percent capital gains rates.

Two facts sharpen the planning. The IRS recaptures depreciation you were ALLOWED to claim whether or not you claimed it, so skipping the deduction only wastes it. And a 1031 exchange defers recapture along with the rest of the gain, which is much of why long-held landlords exchange rather than sell. The 1031 exchange calculator shows how large the recapture layer has grown on your property.