Depreciation Recapture on Rental Property 2026: The 25% Tax Most Sellers Forget About

The Tax Bill Most Rental Sellers Don't See Coming

Depreciation is the single largest deduction most landlords take over the life of a property. What they often forget is that depreciation is a deferral, not a forgiveness. When you sell a rental, the IRS adds every dollar of depreciation you claimed (or were allowed to claim) back into your gain calculation — and taxes a big chunk of it at a rate higher than the long-term capital gains rate most sellers expect.

This is depreciation recapture, and for a property you've held for ten to twenty years, it can easily add $40,000–$120,000 to the tax bill on a sale you thought was a clean capital gain.

This guide covers how recapture actually works, the specific Section 1250 rate cap, the NIIT and state tax layers that stack on top, the "allowed or allowable" rule that catches sellers who never took depreciation in the first place, and the four legitimate paths to defer or eliminate recapture exposure.

What Depreciation Recapture Actually Is

When you sell a rental property at a gain, the IRS splits the gain into two buckets:

Unrecaptured Section 1250 gain — the portion of your gain equal to the depreciation you claimed on the building. Taxed at a maximum federal rate of 25%.
Section 1231 / capital gain — the remaining gain beyond depreciation. Taxed at long-term capital gains rates (0%, 15%, or 20% depending on income).

The word "recapture" is slightly misleading. For real property (rentals, commercial buildings), the IRS doesn't actually tax your depreciation at ordinary income rates the way it does for personal property under §1245. Instead, it taxes the depreciation-equivalent portion of your gain at a maximum of 25% under the "unrecaptured §1250 gain" rules in IRC §1(h). This is still a rate bump from the 15% or 20% long-term cap gains rate most sellers assume applies to the whole gain.

Example: A 10-Year Hold

Purchase price: $400,000 ($320,000 building, $80,000 land) Annual straight-line depreciation: $11,636 ($320,000 ÷ 27.5) Total depreciation claimed over 10 years: $116,360

Sale price after 10 years: $600,000 Selling costs: $36,000 Adjusted basis: $400,000 − $116,360 = $283,640 Amount realized: $600,000 − $36,000 = $564,000 Total gain: $564,000 − $283,640 = $280,360

Now split the gain:

Unrecaptured §1250 gain (taxed at up to 25%): $116,360
Long-term capital gain (taxed at 15% or 20%): $164,000

At a 15% LTCG rate and 25% recapture rate, federal tax on the sale is:

Recapture: $116,360 × 25% = $29,090
LTCG: $164,000 × 15% = $24,600
Total federal: $53,690

Had the whole gain been taxed at 15%, the bill would have been $42,054. The recapture adds nearly $12,000 to the federal tax just from the rate difference on the depreciation portion. And we haven't added NIIT or state tax yet.

Why the 25% Cap Is Not a "Low Rate"

Sellers sometimes assume 25% is just the ordinary-income rate they'd otherwise pay, so recapture is "free." That's wrong for two reasons:

The 25% rate is a cap, not a fixed rate. If you're in the 24% marginal bracket, your recapture rate is 24%, not 25%. The cap only kicks in for high-bracket taxpayers.
The comparison point should be the long-term capital gains rate, not ordinary income. Without recapture, the same dollars would be taxed at 0%, 15%, or 20%. The 25% cap is often 5–10 points higher than what the gain would have been taxed at absent the recapture rule.

NIIT Adds 3.8% on Top

Unrecaptured §1250 gain is investment income. If your MAGI exceeds the NIIT thresholds ($200k single / $250k MFJ), the Net Investment Income Tax adds 3.8% on top of the 25% recapture rate.

Effective rate on recapture for high earners: 28.8%

This is where the "I thought I was in the 15% cap gains bracket" shock hits. A seller with a $500,000 W-2 plus a $280,000 gain on a rental sale is paying:

25% on $116,360 of recapture = $29,090
3.8% NIIT on $116,360 = $4,421
20% on $164,000 of LTCG = $32,800
3.8% NIIT on $164,000 = $6,232
Federal total: $72,543 (an effective 25.9% on the $280k gain)

State tax stacks on top — California, for example, taxes the entire gain at ordinary state rates (up to 13.3%). A California seller in this scenario would add another ~$37,000 in state tax, bringing the total blended tax on the gain to $109,500 — about 39% of the gain.

For most high-earner landlords, the recapture plus NIIT plus state stack is the single largest tax event of the entire rental cycle. Ignoring it until the closing table is a planning failure.

The "Allowed or Allowable" Trap

Here is the rule most sellers don't know: depreciation recapture is computed on the depreciation you claimed OR on the depreciation you were allowed to claim, whichever is greater.

This is the IRS's "allowed or allowable" rule under §1016(a)(2). It means that if you owned a rental for 10 years and never took depreciation (a common mistake for landlords who self-prepared or had a CPA who didn't know rental real estate), the IRS still reduces your basis by the depreciation you should have taken. You pay recapture tax on depreciation you never claimed as a deduction.

The fix: before selling, file Form 3115 to claim the missed depreciation under the automatic accounting method change. You recover 10 years of deductions in one tax year (a Section 481(a) adjustment), which partially offsets the recapture you're about to owe on the sale. See the Form 3115 catch-up guide for the mechanics.

Filing order matters: file Form 3115 in the tax year before the sale, not in the sale year itself. A late-filed Form 3115 can still work, but the deduction timing becomes less clean and may trigger IRS scrutiny on a high-dollar sale.

What Recapture Looks Like on the Tax Return

The recapture calculation flows through a specific form sequence:

Form 4797 (Sales of Business Property): Part III, Section C for §1250 property. You identify the property, sale price, adjusted basis, and total gain.
Schedule D: The Section 1231/capital gain portion flows to Schedule D.
Unrecaptured §1250 Gain Worksheet (Schedule D instructions): Calculates the portion of gain taxed at the 25% cap.
Form 8960 (if MAGI over NIIT threshold): Includes the entire gain (both recapture and LTCG portions) in the NIIT base.

The common filing errors:

Reporting the sale on Schedule D alone (missing Form 4797 and the unrecaptured §1250 treatment)
Taking the entire gain at LTCG rates (ignoring the 25% recapture bucket)
Forgetting to include the gain in NIIT for high-MAGI years
Using purchase price as the adjusted basis instead of purchase price less accumulated depreciation

The Four Ways to Defer or Avoid Recapture

1. §1031 Like-Kind Exchange (Full Deferral)

A §1031 exchange of the relinquished rental for a replacement investment property defers both the capital gain and the recapture indefinitely. Your depreciation exposure, along with the unrecognized gain, carries over into the new property's basis. You'll pay the tax whenever you eventually sell without another exchange — or never, if you die holding the replacement property (see step 4).

Key requirements:

Replacement property identified within 45 days of sale
Acquisition closed within 180 days
Equal-or-greater value and debt (or pay tax on the "boot")
Qualified intermediary holds proceeds; you cannot touch the cash

See the 1031 exchange guide for rental investors for the step-by-step timeline.

2. Installment Sale (Partial Deferral)

An installment sale under IRC §453 spreads the capital gain portion over the years payments are received. However, depreciation recapture is fully taxable in the year of sale, regardless of how much cash you actually receive. Under §453(i), §1245 recapture is accelerated to the sale year; §1250 recapture (for real property) is more nuanced — the excess of accelerated depreciation over straight-line is accelerated, but because most rental owners used straight-line, there's often no §1250 "recapture" in the traditional sense to accelerate.

What this means in practice: an installment sale defers the LTCG portion but the 25% unrecaptured §1250 gain generally still flows through in the first year. Run the math before using installment sales to defer recapture — it often doesn't do what sellers hope.

3. Convert to Primary Residence, Then Sell Under §121

Converting a rental back to a primary residence for at least two of the five years before sale qualifies you for the §121 exclusion: $250k of gain tax-free (single), $500k (MFJ). Important caveats:

Recapture is NOT excluded by §121. The unrecaptured §1250 gain for periods of "non-qualified use" (i.e., the rental years) is still taxed at up to 25%.
Gain allocated to post-2008 non-qualified use is fully taxable.
Only the portion of gain attributable to the primary-residence period is eligible for the $250k/$500k exclusion.

See the converting rental to primary residence guide for the inverse flow (primary → rental) and the same rules in reverse.

4. Hold Until Death — Step-Up in Basis

If you die holding the rental, your heir receives a stepped-up basis equal to fair market value at your date of death under §1014. All depreciation recapture exposure disappears. This is the most tax-efficient exit in the code — you never pay the deferred tax, and your heir starts a new 27.5-year depreciation clock on the stepped-up basis.

This is often the answer for long-term holders in the 60+ age band. The cost of selling now at a 25% recapture rate plus NIIT plus state tax frequently exceeds the cost of holding and letting the step-up do the work.

See the inherited rental property guide for the heir's mechanics — and the planning implications for the current owner.

Planning Moves Before a Sale

Order a depreciation schedule review. Confirm the actual accumulated depreciation on your property. Sellers are often surprised by the number after 10–20 years.
Calculate the blended tax stack now, not at closing. Recapture + LTCG + NIIT + state tax. The headline sale price minus selling costs is not your net proceeds.
File Form 3115 in the year before the sale if you missed depreciation in earlier years — you can recover it before the recapture hits.
Evaluate 1031 vs. sell. If you're reinvesting in real estate anyway, the exchange is essentially free tax deferral. The 25% recapture you'd owe on a straight sale funds the down payment on a bigger property.
For high-earner sellers: time the sale into a low-income year. Recapture is still capped at 25%, but the LTCG bracket (0% / 15% / 20%) and NIIT threshold are taxable-income sensitive. A sabbatical year, retirement year, or deliberate income-deferral year can save 5–7 points of blended tax.
Don't mix recapture with a §121 sale and assume you get the exclusion. The exclusion doesn't touch recapture and doesn't touch non-qualified-use gain. Run the pro-rata calculation.

The Bottom Line

Depreciation recapture is the tax that turns a "simple" rental sale into a multi-bucket calculation. The 25% cap, the 3.8% NIIT, the state tax stacking, and the "allowed or allowable" trap all compound — but every one of them is visible years in advance if you look. Sellers who run the numbers before listing, and who think of 1031, installment, conversion, or hold-until-death as active choices rather than afterthoughts, keep meaningfully more of their proceeds.

If you're heading toward a sale, use the RentalDeductions calculator to estimate your accumulated depreciation and the recapture exposure. If you discover missed depreciation during that review, the Form 3115 catch-up process is the fix. If you're planning to reinvest, the 1031 exchange guide covers the timeline. And if you've inherited the property you're now considering selling, the inherited rental guide explains why your recapture exposure may already be zero.