Tax Guides

Depreciation Recapture Explained

Depreciation recapture is often the most misunderstood part of a real estate sale, and it can add a meaningful amount to the tax bill on a Dallas, TX property beyond ordinary capital gains tax. During ownership, an investor generally deducts depreciation on the building and qualifying improvements each year, which reduces taxable income at the time but also reduces the property's adjusted basis. When the property is later sold, the portion of gain attributable to that previously claimed depreciation is generally taxed as unrecaptured Section 1250 gain, at a maximum federal rate of twenty five percent, which is higher than the top long term capital gains rate that applies to the remaining gain. Unlike Section 1245 recapture that can apply to certain personal property at ordinary income rates, unrecaptured Section 1250 gain on real property is capped at twenty five percent under current law. Because the recapture amount is generally locked in as soon as depreciation has been claimed, it cannot be avoided simply by holding the property longer, and it is generally due upon any taxable sale regardless of how long the depreciation was claimed. A fully qualifying 1031 exchange generally defers both the capital gains component and the depreciation recapture component together, since the replacement property's basis is generally calculated by carrying forward the relinquished property's adjusted basis. Texas has no state income tax, so recapture exposure for North Texas investors is generally limited to the federal amount. This page is general education, and investors should request a depreciation recapture estimate from their tax preparer using their actual depreciation schedule.