Tax Guides
Depreciation Recapture Explained
A general explainer of unrecaptured Section 1250 depreciation recapture on real estate sales, and how a 1031 exchange defers it.
Tax Guides
Capital Gains On Rental Property Explained
Selling a rental property in Dallas, TX generally triggers two separate federal tax items. The first is capital gains tax on the difference between the sale price and the adjusted cost basis, taxed at long term rates of up to twenty percent for property held more than one year, plus the three point eight percent net investment income tax for many higher income filers. The second is unrecaptured Section 1250 depreciation recapture, taxed at a maximum federal rate of twenty five percent on the portion of gain attributable to depreciation already claimed. Texas does not impose a state income tax, so investors selling rental property in North Texas generally owe only the federal amounts, which still commonly reach a quarter or more of total gain once both items are combined. A properly structured 1031 exchange allows an investor to defer both the capital gains tax and the depreciation recapture by reinvesting net proceeds into qualifying like kind replacement real property held for investment or business use, using a qualified intermediary so the investor never receives or controls the sale proceeds directly. Deferral is not forgiveness. Tax is generally due if and when the replacement property is eventually sold without another exchange, though basis can carry forward indefinitely across multiple exchanges. This page describes general federal tax mechanics and is not a substitute for a projection prepared by a qualified tax professional using the actual basis, depreciation schedule, and sale price of a specific Dallas property.
Why it matters
- Rental property sales generally trigger long term capital gains tax, unrecaptured Section 1250 depreciation recapture, and potentially the net investment income tax at the federal level.
- Texas imposes no state income tax, so Dallas, TX investors generally face only the federal tax layers described above on a rental property sale.
- A 1031 exchange can defer both the capital gains and the depreciation recapture components when net proceeds are reinvested into qualifying replacement real property.
- Deferral requires a qualified intermediary and generally requires the investor to never take actual or constructive receipt of sale proceeds.
- Basis in the relinquished property generally carries forward into the replacement property, which affects future depreciation schedules and future gain calculations.
Deliverables
- A general summary of the capital gains and depreciation recapture components that apply to a rental property sale.
- An explanation of how the qualified intermediary structure preserves 1031 eligibility.
- Notes on how Texas having no state income tax affects the total tax picture for Dallas, TX sellers.
- A comparison of a taxable sale versus a deferred exchange using general assumptions.
- A referral pathway to a tax professional for a property specific projection.
Milestone Schedule
Before listing
Review adjusted basis and depreciation schedule with a tax professional before marketing the property.
Under contract
Engage a qualified intermediary before closing on the relinquished property in Dallas, TX.
After closing
Begin the forty five day identification window for replacement property to preserve deferral.
Frequently Asked Questions
How is capital gains tax calculated on a Dallas, TX rental property sale?
Gain is generally calculated as the sale price minus selling costs and adjusted basis, with adjusted basis reduced by depreciation already claimed on the Dallas, TX property. A tax professional should confirm the exact figures.
Does the forty five day identification period apply if I want to defer this gain?
Yes. To defer the gain through a 1031 exchange, replacement property generally must be identified within forty five days of closing on the relinquished property and acquired within one hundred eighty days.
What is boot and how does it affect capital gains on a rental sale?
Boot is any cash, debt relief, or non like kind property received in an exchange. Receiving boot generally triggers recognition of gain up to the value of the boot, even within an otherwise valid exchange.
Does Texas add its own capital gains tax on top of the federal amount?
No. Texas has no state income tax, so investors selling rental property in Dallas, TX generally owe only the federal capital gains and depreciation recapture amounts.
Is depreciation recapture deferred along with capital gains in a 1031 exchange?
Generally yes, when the exchange is fully valid and no boot is received. Both the capital gains and the unrecaptured Section 1250 depreciation recapture components are generally deferred together.
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The Forty Five Day Identification Period
A plain language explainer of the forty five day identification window that governs every like kind exchange under Section 1031.
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What Is Boot in a 1031 Exchange
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