Taxes Tax Planning What Is Depreciation Recapture? By Beverly Bird Updated on January 25, 2023 Reviewed by Ebony J. Howard Reviewed by Ebony J. Howard Ebony Howard is a certified public accountant and a QuickBooks ProAdvisor tax expert. She has been in the accounting, audit, and tax profession for more than 13 years, working with individuals and a variety of companies in the health care, banking, and accounting industries. learn about our financial review board In This Article View All In This Article How Depreciation Recapture Works Examples of Depreciation Recapture Not Claiming Depreciation Won't Help How To Plan for Depreciation Recapture Additional Resources About Depreciation Recapture Photo: Evgeniia Siiankovskaia / Getty Images Definition Depreciation recapture is a tax concept in which you can divide and spread out the cost of an asset over several years of its useful life and take a tax deduction for that amount in each of those years, but the IRS stands by to collect those taxes when and if you sell the asset in question. Key Takeaways Depreciation recapture is the IRS' way of recouping taxes from deductions you made for the depreciation of an asset that you sell.Depreciation recapture can have a big impact on the sale of residential real estate property.Generally speaking, the depreciation recapture tax rate is 25%.A like-kind exchange can help you avoid paying depreciation recapture. How Depreciation Recapture Works Not all assets depreciate at the same rate. Automobiles are notorious for losing value the moment you drive a new one off the dealership lot, but real estate can appreciate over years of ownership. You might also realize a profit and a capital gain if you sell the property for more than your cost basis in it but you were taking a tax deduction for its decreasing value over those years of ownership. That’s double-dipping in the eyes of the IRS and the federal tax code. The IRS therefore recaptures your depreciation, requiring that you pay the taxes you didn’t pay during your period of ownership because you were claiming a deduction. Note A capital gain is the difference between an asset’s adjusted cost basis and what you sell it for, and capital gains are taxable. Reducing the asset’s basis through depreciation results in more of a gain. Depreciation recapture can cause a significant tax impact if you sell a residential rental property. Part of the gain can be taxed as a capital gain, and it might qualify for the maximum 20% rate on long-term gains, but the part that’s related to depreciation can be taxed at the 25% depreciation recapture rate. Note The technical term for a gain related to depreciation on residential property is “unrecaptured Section 1250 gain.” How your gain is recaptured depends on the type of asset in question. Section 1250 of the tax code applies to real estate property, whereas Section 1245 applies to other types of assets. Each sets forth the circumstances under which recapture can be taxed as ordinary income rather than at the 25% rate. Residential Rental Properties: Section 1250 Section 1250 applies to all property sold or disposed of after December 31, 1975. It provides that any gain on the sale of a property may be taxed as ordinary income, according to your marginal or top tax bracket, based on whichever of the following is less: The depreciation you claimed The difference between the sales price or fair market value (in the event that you don’t sell the property) and the adjusted basis of the property Otherwise, it’s subject to the 25% rate rather than the more advantageous capital gains rate. Other Property: Section 1245 Section 1245 applies to property not including “a building or its structural components,” according to the tax code. A portion of this property is taxed as ordinary income to the extent that the sales price exceeds the lesser of: The “recomputed” basis of the property by adding back deductionsThe sales price or the asset’s fair market value Again, the recapture is otherwise taxed at the 25% rate, not at the more favorable capital gains tax rate. Examples of Depreciation Recapture As an example, suppose you purchased a rental property for $150,000. You depreciated it for tax purposes at a rate of $5,400 a year for five years. You were in the 32% tax bracket in each of those years, so you avoided $1,728 each year in taxes that you didn’t have to pay: 32% of $5,400 for five years, for a total of $8,640 in savings. You’d owe $6,750 in tax if the IRS taxed your claimed depreciation amount ($27,000 total) at the 25% depreciation recapture rate, and you might owe capital gains tax as well. You saved $8,640 in taxes, so you’re actually only seeing a profit of $1,890—the difference between $6,750 and $8,640—because the IRS effectively reclaimed that depreciation. Not Claiming Depreciation Won't Help It might seem reasonable that you could not claim a depreciation deduction to avoid paying the recapture tax. This strategy doesn’t work, however, because tax law requires that recapture be calculated on depreciation that was "allowed or allowable," according to the IRS' tax code. In other words, you were entitled to claim depreciation even if you didn’t, so the IRS treats the situation as though you had. Note Taxpayers should generally claim depreciation on the property to get the associated tax deduction, because they’ll have to pay tax on the gain due to the depreciation anyway, when and if they eventually sell. How To Plan for Depreciation Recapture Here's some good news: Passive activity losses that were not deductible in previous years have become fully deductible when a rental property is sold. This can help offset the tax bite of the depreciation recapture tax. A rental property also can be sold as part of a like-kind exchange to defer both capital gains and depreciation recapture taxes. This involves disposing of an asset and immediately acquiring another similar asset, effectively deferring taxes until a later point when a sale is not followed by an acquisition. Additional Resources About Depreciation Recapture Here are some additional resources from the IRS website regarding depreciation that you might find helpful: IRS Publication 527, Residential Rental Property IRS Publication 544, Sales and Other Dispositions of Assets: Especially the section in Section 3 dealing specifically with depreciation recapture Instructions for Schedule D: Look for the worksheet on page D-14, which helps you calculate the depreciation recapture tax IRS FAQs for the sale or trade of business, depreciation, and rentals Frequently Asked Questions (FAQs) Can I avoid depreciation recapture? Generally, you can't avoid depreciation recapture if you record a gain on the sale of an asset for which you record depreciation. Whether or not you actually took the depreciation when it was available, the IRS will tax you on the recapture. However, if you sell the property at a loss or trade it for "like-kind" property of a similar value, you will not be taxed on the depreciation recapture. Where do I report depreciation recapture? You'll report depreciation recapture on IRS Form 4797, which is for recording the sale of business property. For any personal gains, you'll use Schedule D and Form 1040. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. WilkinGuttenplan CPA & Advisors. "Tax Matters: Tax Implications of 'Depreciation Recapture' When Selling Real Estate." IRS. "Publication 544: Sales and Other Dispositions of Assets." Cornell Law School Legal Information Institute. “26 U.S. Code Section 1250 – Gain From Dispositions of Certain Depreciable Realty.” Cornell Law School Legal Information Institute. “26 U.S. Code Section 1245 – Gain From Dispositions of Certain Depreciable Property.” Cornell Law School Legal Information Institute. "Recomputed Basis." IRS. "Like-Kind Exchanges—Real Estate Tax Tips."