Depreciation Recapture on Rentals: Rates, Examples, Fixes

Depreciation recapture is the tax you pay when you sell a rental for more than its depreciated value: the IRS takes back part of the depreciation deductions you claimed while you owned it. On a residential rental held more than a year, the building’s share of that gain is taxed at a maximum 25% federal rate, while any short-life items carved out through cost segregation are recaptured as ordinary income. If you buy and hold, as a BRRRR investor, a cash buyer or a wholesaler moving into rentals, plan for this bill the day you buy.

27.5 yrsresidential rental recovery period (IRS Pub 527)

25%max rate on unrecaptured Section 1250 gain (IRS Topic 409)

3.8%net investment income tax above MAGI thresholds (IRS Topic 559)

Below: a full worked sale, the same rental with and without cost segregation, what the 2025 tax law changed about bonus depreciation, and how buyers price the exit tax into their offers.

How a rental gets depreciated before anything is recaptured

Under the IRS’s standard system (GDS under MACRS), residential rental property is depreciated straight-line over 27.5 years, according to IRS Publication 527. Nonresidential real property, such as an office building, store or warehouse, uses 39 years, per Publication 946. A building counts as residential rental property if at least 80% of its gross rental income comes from dwelling units.

Three rules decide the size of your deduction:

Land is never depreciated. The IRS says you can’t depreciate land because it doesn’t wear out, become obsolete or get used up. Split the price by fair market value, or, per Pub 527, by the property tax assessment ratio if you’re unsure.
The clock starts when the unit is ready and available for rent, not when you close and not when a tenant moves in.
The mid-month convention applies. All residential rental and nonresidential real property is treated as placed in service, or disposed of, at the midpoint of the month. A January start gets 11.5 months in year one (3.485% instead of the full-year 3.636%).

Some items in a rental fall into shorter classes. Pub 527 puts appliances, carpeting and furniture used in a residential rental activity in the 5-year class, and roads, fences and shrubbery (if depreciable) in the 15-year class. Cost segregation pulls these items out of the building’s basis, and they’re recaptured differently.

Every dollar you deduct lowers your adjusted basis. Sell above that lower basis and the depreciation comes back as taxable gain.

What depreciation recapture actually taxes when you sell

For a typical rental held more than one year, the gain on the sale gets split into layers, and each layer has its own rate. The sale is reported on Form 4797; the Form 4797 instructions route depreciable real property sold at a gain through Part III (Section 1250), and depreciable personal property through Part III (Section 1245).

Layer of gain	Where it comes from	Federal treatment
Section 1245 recapture	Depreciation (including bonus) on personal property such as appliances, carpet, and cost-segregated components	Ordinary income, up to the lesser of the gain on those items or the depreciation taken
Unrecaptured Section 1250 gain	Straight-line depreciation on the building	Taxed at your ordinary rate, capped at 25%
Remaining long-term gain	Appreciation above your original basis	0%, 15% or 20% depending on taxable income
Net investment income tax	Applies across the whole gain for many landlords	Extra 3.8% if MAGI is above the threshold

IRS Topic 409 states that the portion of any unrecaptured Section 1250 gain from selling Section 1250 real property is taxed at a maximum 25% rate. Pub 544 defines that gain as the part of the long-term gain on real property that comes from depreciation. Because residential MACRS is straight-line, individual landlords usually have no “additional depreciation” for Section 1250 to tax as ordinary income, so building recapture lands in the 25%-capped bucket.

For tax years beginning in 2025, Topic 409 lists the 0% capital gains rate up to $48,350 of taxable income for single filers ($96,700 married filing jointly), with the 15% rate running to $533,400 single ($600,050 joint) and 20% above that. On top of this, Topic 559 applies the 3.8% net investment income tax to the lesser of net investment income or modified AGI above $200,000 (single or head of household), $250,000 (married filing jointly) or $125,000 (married filing separately). Rental gains count unless they come from a trade or business the NIIT doesn’t reach. State income tax comes on top and varies by state.

The “allowed or allowable” trap

Skipping depreciation does not get you out of recapture. Publication 946 requires you to reduce basis by the depreciation “allowed or allowable, whichever is greater.” Allowable means what you were entitled to deduct. A landlord who never claimed it still owes recapture and never got the deductions. If you find missed years, Pub 946 explains that a change in accounting method for depreciation generally requires Form 3115.

A worked depreciation recapture example on a single-family rental

A hypothetical BRRRR deal held ten years (illustrative figures):

Purchase plus capitalized rehab: $250,000 total basis
Land allocation from the tax assessment: $50,000 (20%), leaving a $200,000 depreciable building
Placed in service in January of year 1; sold in January of year 11
Sale price $360,000, selling costs $21,600 (6%), amount realized $338,400
Seller is single with about $210,000 of other taxable income: 32% ordinary bracket, 15% capital gains bracket, MAGI above the $200,000 NIIT threshold

Depreciation from the IRS 27.5-year table: $6,970 in year 1 (3.485%), $7,272 in each of years 2 through 10 (3.636%), and $303 for the half month in the year of sale. That comes to roughly $72,721.

Line	Hypothetical amount
Amount realized ($360,000 − $21,600)	$338,400
Adjusted basis ($250,000 − $72,721)	$177,279
Total gain	$161,121
Unrecaptured §1250 gain at 25%	$72,721 → $18,180
Remaining long-term gain at 15%	$88,400 → $13,260
NIIT at 3.8% on full gain	$6,123
Estimated federal tax on the sale	about $37,563

About 48% of the federal tax bill here, $18,180 of $37,563, comes from recapture, not from the house going up in value. Deducting at up to 32% and repaying at 25% is still a good trade, unless passive loss limits kept you from using the deductions. The exact stacking runs through the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, so have a CPA run your actual numbers before you list.

Same rental, with and without cost segregation

A cost segregation study breaks a building’s cost into components. Some of them, like appliances, carpeting, furniture, fences and roads, qualify for 5- or 15-year lives instead of 27.5. The IRS’s Cost Segregation Audit Techniques Guide describes what examiners expect from a study. The payoff is faster deductions. The catch: those components are Section 1245 property, recaptured as ordinary income.

Bonus depreciation is what makes this matter. P.L. 119-21, commonly called the One Big Beautiful Bill Act, restored the 100% special depreciation allowance for qualified property acquired and placed in service after January 19, 2025, per Publication 946. The IRS described it as a permanent 100% deduction when it released Notice 2026-11 in January 2026. Qualified property must generally have a recovery period of 20 years or less, so the 27.5-year building itself does not qualify, but cost-segregated 5- and 15-year components do. Property acquired before January 20, 2025 and placed in service in 2025 stays under the old phase-down at 40%.

Hypothetical comparison: the same $200,000 building, placed in service in January after the 2025 cutoff, sold in January of year 6 for the same $338,400 net. In the cost-seg version, a study moves $40,000 into 5- and 15-year property and takes 100% bonus on it in year 1. At sale, those worn components are allocated $12,000 of the price, and the seller is in the same brackets as above.

Hypothetical, 5-year hold	Straight-line only	With cost segregation
Total depreciation claimed	$36,361	$69,090 ($40,000 bonus + $29,090 building)
Total gain	$124,761	$157,490
§1245 recapture (ordinary, 32%)	$0	$12,000 → $3,840
Unrecaptured §1250 gain (25%)	$36,361 → $9,090	$29,090 → $7,273
Long-term gain (15%)	$88,400 → $13,260	$116,400 → $17,460
NIIT (3.8%)	$4,741	$5,985
Estimated federal tax at sale	about $27,091	about $34,558

The cost-seg owner pays about $7,467 more at sale but claimed $32,729 more in deductions, mostly in year 1. At a 32% bracket, those extra deductions are worth up to about $10,473, and most of that arrives years earlier. That’s a win only if the deductions were usable, and only if the sale allocation to personal property is defensible.

Ways to defer or erase recapture, and what each one really does

1031 exchange: deferral, not forgiveness

A like-kind exchange of real property held for investment or business use postpones recognition, and Pub 544 notes it generally triggers no ordinary depreciation recapture unless you receive cash or other non-like-kind property. You must identify replacement property within 45 days and receive it by the earlier of 180 days or your return due date (with extensions). One trap: Pub 544 warns that Section 1245 recapture can occur when the property you receive isn’t Section 1245 property, so exchanging a cost-segregated rental into a building with no comparable personal property can bring part of that recapture forward. The deadlines and qualified intermediary rules are in our 1031 exchange rules guide.

Installment sale or seller financing: only partly spread out

Under 26 U.S.C. §453(i), recapture income, meaning anything that would be ordinary income under Section 1245 or 1250, is recognized in the year of sale even when you collect nothing that year. Pub 544 repeats the point. So the cost-seg ordinary recapture is taxed up front. Unrecaptured Section 1250 gain is different: Treasury Reg. §1.453-12 lets it follow the installment method, but it is taken into account before your other capital gain, so the first payments carry the 25% layer. Owner-financing a rental to a buyer, covered in our seller financing guide, can spread the tax but won’t delay the recapture on personal property. For how the gross profit percentage and Form 6252 work on a carryback note, see our installment sale guide.

Holding until death: the step-up

Under 26 U.S.C. §1014, an heir’s basis is generally the property’s fair market value at the date of death, and Pub 544 states that no gain is reported on depreciable property transferred at death. Accumulated depreciation, including bonus, effectively disappears. Gifts are the opposite: Pub 544 says the recipient must account for the donor’s depreciation when they later sell. State estate and community property rules change the details, so involve an estate attorney as well as a CPA.

Why flips and wholesale assignments usually never reach recapture

Publication 946 is direct: you cannot depreciate inventory, defined as property held primarily for sale to customers in the ordinary course of business. A fix-and-flip held for resale, or a contract you assign for a fee, is generally dealer or inventory activity. It is not depreciated, so there is nothing to recapture, but profits are usually ordinary income. Pub 544 also excludes property held primarily for sale from 1031 treatment. The details are in our wholesale real estate taxes breakdown. The moment you keep a deal as a rental, it starts depreciating, and the rules above apply to you.

How buyers price recapture into what they pay for a rental

Recapture never passes to the buyer. Per Publication 551, the basis of property you buy is usually its cost, so a cash buyer starts a fresh depreciation schedule on their own purchase price. Experienced buy-and-hold investors still factor it into what they’ll pay in three ways:

They model the exit, not just the cash flow. A strong cash-on-cash return looks different after a 25% recapture layer and 3.8% NIIT at sale. Running both the hold and the exit, for example in our BRRRR calculator or cash-on-cash return calculator, keeps you from overpaying for paper returns.
They pick an exit before they buy. A buyer planning to 1031 or hold until death can treat depreciation as close to permanent. A five-year exit makes part of it a loan from the IRS, so bid accordingly.
They size cost segregation to the plan. On a BRRRR refinance, bonus depreciation can offset income in year one. On a short hold it mostly moves taxes around. Turnkey buyers, whose numbers are covered in our turnkey rental guide, should ask anyone pitching cost seg how the ordinary-income layer at sale was modeled.

For wholesalers, it matters on acquisitions too. A long-time landlord with a low basis may net far less after recapture than they expect, which shapes the price they’ll accept and why some prefer seller financing. Their real net operating income and a rough after-tax figure build more trust than a bigger headline offer.

Where rental investors get burned on recapture

Skipping depreciation to “avoid” recapture. The allowed-or-allowable rule means you pay anyway and lose the deductions.
Assuming the bonus deduction was usable. Rental losses are generally passive. Pub 527 allows up to $25,000 of rental losses for active participants, but the allowance phases out between $100,000 and $150,000 of MAGI. Above that, losses get suspended unless you qualify as a real estate professional for tax purposes. Pub 925 shows suspended deductions being freed when you sell your entire interest to an unrelated person, but by then the timing benefit is gone.
Selling with a sloppy price allocation. Undervaluing personal property at sale shrinks the ordinary layer on paper, and an aggressive number is easy to challenge.
Lowballing the land allocation. A bigger building share means bigger deductions now, bigger recapture later, and exam risk.
Treating an installment sale as a full deferral. Section 453(i) puts ordinary recapture in year one, cash or no cash.
Exchanging into the wrong replacement. A cost-segregated relinquished property going into raw land or a property with no personal property can trigger Section 1245 recapture even inside a 1031.
Losing records. Pub 544 says to keep permanent records of cost, depreciation and basis adjustments.

Depreciation recapture questions investors ask

Is depreciation recapture always taxed at 25%?

No. 25% is the maximum federal rate on unrecaptured Section 1250 gain. If your ordinary bracket is lower, that slice can be taxed at less. Section 1245 recapture from cost segregation is ordinary income at your full rate, and NIIT may add 3.8%.

Does recapture apply if I sell at a loss?

Recapture only taxes gain. If the amount realized is below your adjusted basis, there is no gain to recapture, and the loss follows the Section 1231 rules in Pub 544.

Does a cash-out refinance trigger recapture?

No. A refinance is not a sale or exchange, so nothing is recaptured. That’s part of why BRRRR investors refinance instead of selling.

Is the 100% bonus depreciation really permanent?

The IRS described it that way in its January 2026 guidance under Notice 2026-11, for qualified property acquired after January 19, 2025. Check irs.gov in the year you buy.

Keep building your rental exit plan

1031 Exchange RulesDeadlines and how deferral works The BRRRR MethodBuy, rehab, rent, refinance, repeat Wholesale Real Estate TaxesHow assignment fees are taxed Turnkey Rental PropertyWhat to check before you buy Cash-on-Cash ReturnThe cash flow metric buyers use Net Operating IncomeUnderwriting a rental’s income IRR in Real EstateMeasuring returns across the hold Seller FinancingStructuring owner-carry deals

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