Depreciation Recapture: The Hidden 1031 Tax Saver

What is depreciation recapture?

When you own a rental property, you take annual depreciation deductions against rental income. For residential real estate, depreciation is taken over 27.5 years on the structure (not the land). For commercial, it's 39 years.

Depreciation reduces your taxable rental income every year you own the property — a straightforward tax benefit. But it also reduces your adjusted basis in the property. The lower your basis, the bigger the taxable gain when you sell.

When you sell, the IRS claws back the tax benefit. The portion of gain attributable to depreciation already taken is taxed at a special 25% rate under Section 1250 — the depreciation recapture rate. Everything above that recaptured amount is taxed at regular capital gains rates.

The 25% recapture rate vs capital gains rates

Capital gains rates vary by income: 0%, 15%, or 20% for long-term gains. Most real estate investors land at 15% or 20%.

Depreciation recapture is a flat 25% regardless of income bracket. That's higher than most investors' capital gains rate.

For a property held long enough that total depreciation taken exceeds the true appreciation, recapture can actually be the majority of your tax bill on the sale. This surprises a lot of investors who've mentally budgeted for 15-20% capital gains tax and get hit with 25% on a bigger portion of the gain than expected.

How a 1031 defers both

A 1031 exchange defers both the capital gains tax and the depreciation recapture. Neither gets paid when you sell the relinquished property — they both roll forward into the replacement property's tax basis.

Specifically, the replacement property inherits a carry-over basis equal to your relinquished property's adjusted basis (plus any new cash you brought into the deal). That deferred gain includes both deferred appreciation and deferred depreciation recapture, tracked separately on Form 8824.

The practical effect: on a property where you'd owe say $80k in capital gains tax and $120k in recapture, you defer all $200k, not just the $80k most investors remember.

When does recapture resurface?

Two scenarios:

• You eventually sell the replacement outside of a 1031. All the deferred gain from every prior exchange (including recapture) comes due at sale. The accounting can be complex if you've done multiple 1031s — each one added deferred amounts. Form 8824 for every exchange is part of the permanent record.
• You die holding the property. This is the elegant endgame. At death, your heirs receive a stepped-up basis equal to the fair market value of the property on your date of death. All the deferred capital gains and deferred depreciation recapture are wiped out permanently. Your heirs can sell immediately with zero tax.

"Swap 'til you drop" is the strategy that takes advantage of this. Keep doing 1031s for decades, never pay tax on any exchange, and your heirs inherit with zero tax liability. This is why the long-term wealth-building math on 1031s is so powerful.

Real example — why recapture matters

Consider a Brooklyn rental bought in 2010 for $800k, with $640k attributable to the structure (80% building/20% land is a common allocation). Sold in 2026 for $1.5M.

• Annual depreciation: $640k / 27.5 = $23,273/year
• 16 years of depreciation: $23,273 × 16 = $372,364
• Adjusted basis at sale: $800k - $372,364 = $427,636
• Total gain: $1.5M - $427,636 = $1,072,364

Breaking down the tax:

• Depreciation recapture (taxed at 25%): $372,364 × 25% = $93,091
• Remaining gain (taxed at 20% federal capital gains for high earners): $700,000 × 20% = $140,000
• Plus NY state tax on the full gain: ~$107,000
• Total tax liability without 1031: ~$340,000

With a 1031, all $340k is deferred — and if held until death, permanently eliminated via basis step-up. Without the 1031, you'd need a $1.5M replacement purchase to recover the pre-tax equity.

How to calculate your own recapture

Three numbers you need:

1. Total depreciation taken. Look at Schedule E filings since you acquired. Your CPA can pull the exact number from your depreciation schedule.
2. Adjusted basis at sale. Original cost + capital improvements - depreciation taken.
3. Sale price. Minus closing costs.

Total gain = sale price - adjusted basis. Of that total gain, the portion equal to total depreciation taken is recaptured at 25%. The rest is capital gains at your normal rate.

Our depreciation recapture calculator handles this automatically — you enter your original purchase, year acquired, and sale price and it spits out the recapture tax, capital gains tax, and total tax deferred in a 1031.