Depreciation Recapture: What Happens When You Sell

When you sell a rental at a gain, the part of the gain that equals the depreciation you took, or were entitled to take, is taxed differently from the rest. If you held the property more than a year, depreciation on the building is taxed as unrecaptured Section 1250 gain, at your ordinary income rate but no more than 25%; if you held it a year or less, the whole gain is taxed at ordinary rates. Depreciation on appliances, carpet, furniture, and other personal property, including parts of a building that a cost segregation study reclassified, is taxed as Section 1245 recapture, which is ordinary income at up to 37% for 2026. A 1031 exchange can postpone recapture and holding the property until death removes it for your heirs, but the home sale exclusion does not cover it and an installment sale does not delay the ordinary-income part.

Your basis drops by depreciation you could have taken, even if you did not

Each year you own a rental, your basis (the cost figure used to compute gain) drops by the depreciation allowed or allowable, whichever is greater. "Allowable" means the amount you were entitled to deduct. If you never claimed depreciation, your basis still drops by the full allowable amount, so your taxable gain at sale is as large as if you had claimed it, and you pay tax on deductions you never received.

If you missed depreciation, fix it before you sell:

• Missed on one return: you can generally file an amended return for that year, within 3 years after you filed it or 2 years after you paid the tax, whichever is later.
• Missed on two or more returns in a row: the IRS treats that as an accounting method, and the fix is generally Form 3115, a request to change accounting method. The missed depreciation is then deducted in the year of the change as a one-time catch-up amount instead of amending each year, and like any rental deduction it is subject to the passive loss limits in IRS Publication 925.

Depreciation on rental property shows how the yearly amounts are figured.

The two kinds of recapture

A cost segregation study moves part of a building's cost into shorter-lived classes, and the parts that become 5- or 7-year personal property fall in the right-hand column. Land improvements such as fences, sidewalks, and shrubbery are 15-year property but count as real property, so they stay in the building column, except that any depreciation on them above the straight-line amount (equal deductions each year), including bonus depreciation, is taxed as ordinary income at sale, up to the gain on them. A residential building depreciated on a straight line over 27.5 years has no such excess, so all of its depreciation stays in the 25% column.

A worked example

You bought a rental house in 2019 for $400,000: $80,000 for the land, $300,000 for the building, and $20,000 for appliances and carpet. By the 2026 sale, you have claimed $76,000 of depreciation on the building and the full $20,000 on the appliances and carpet. You sell for $560,000 and pay $34,000 in selling costs, so the amount realized (sale price minus selling costs) is $526,000.

The amount realized is allocated among the assets based on their fair market values: $4,000 to the appliances and carpet, $110,000 to the land, and $412,000 to the building.

1. Personal property recapture: $4,000 allocated minus a $0 adjusted basis is a $4,000 gain. The smaller of that or the $20,000 of depreciation is $4,000, taxed as ordinary income. The other $16,000 of depreciation on those items is not taxed at sale, because they are worth only $4,000.
2. Building depreciation: the building's adjusted basis is $300,000 minus $76,000, or $224,000, so its gain is $412,000 minus $224,000, or $188,000. The smaller of the $76,000 of building depreciation or that gain is $76,000, taxed at no more than 25%.
3. Long-term capital gain: the rest of the building's gain, $112,000 ($188,000 minus $76,000), plus the land's $30,000 gain ($110,000 minus $80,000), for $142,000.

Here is the federal tax for a married couple filing jointly at two income levels, before the 3.8% net investment income tax:

At $650,000 of other income, the building's depreciation would have been taxed at 35% without the 25% cap, and the capital gain is taxed at 20% because other income alone is already past the $613,700 joint threshold. Capital gains tax on investment property covers the 2026 brackets and the net investment income tax.

How recapture is reported

Form 4797 figures the gain on each asset you sold and pulls out the ordinary-income recapture: line 25 for personal property, and line 26 for any excess depreciation on real property, which is zero for a residential building depreciated on a straight line. The rest of the gain is treated as long-term capital gain if your gains and losses on business and rental property for the year net to a gain. The exception: if you deducted a net loss on that kind of property in the previous five years and later gains have not yet used it up, an equal amount of this year's gain is ordinary income.

The 25% part does not get its own line on Form 4797. You figure it on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, using the smaller of the depreciation or the gain from Form 4797, and enter the result on Schedule D, line 19.

What postpones or removes recapture, and what does not

Three conditions limit the 1031 exchange. The exchange is taxable in the year it closes to the extent you take out cash or pay off a mortgage without replacing it with new debt or added cash, capped at your gain and reduced by exchange expenses such as commissions. Only real property qualifies, so gain on appliances, furniture, and other personal property you give up is taxed. And if a cost segregation study classified parts of the old building as personal property, the exchange can still trigger ordinary-income recapture on those parts even when you take no cash out; have your preparer run that calculation before you choose replacement property. Deadlines and identification rules are in 1031 exchange timelines and rules.

In Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, community property owned by a married couple, including the surviving spouse's half, generally gets a new basis when either spouse dies, as long as at least half its value is included in the estate. Estate planning for rental property owners covers how the step-up in basis fits into a plan for heirs, and tax planning strategies for rental property income covers the other choices that shape the tax on a sale.