When you sell a depreciated property, the IRS requires you to recapture the depreciation you've taken over the years, meaning you pay tax on the portion of your sales gain attributed to that depreciation. This doesn't mean paying back all the tax you saved, but rather taxing that specific portion of the gain at a different, generally higher, rate than standard capital gains.
Here's how it works: the depreciation you claimed is taxed as depreciation recapture income, typically at a maximum federal rate of 25%. Any profit remaining beyond that depreciated value is then taxed as capital gains, which generally benefits from lower rates. The good news is that strategic property tax planning, such as a 1031 Exchange, buying a property in the same tax year, or applying Cost Segregation with Bonus Depreciation on a new purchase, can help defer this tax burden and continue pushing the tax down the line.
Depreciation Recapture: Key Facts
- Mechanism: When you sell, the IRS requires you to recapture the depreciation claimed, taxing that portion of your gain.
- Recapture Tax Rate: Depreciation recapture income is typically taxed at a maximum federal rate of 25%.
- Capital Gains: Any remaining profit beyond the depreciated value is taxed as lower-rate capital gains.
- Deferral Strategies: Tax planning strategies that help defer this tax burden include:
- 1031 Exchange (to defer gain entirely).
- Buying a new property in the same tax year.
- Applying Cost Segregation with Bonus Depreciation on a new purchase to generate offsetting losses.
