What is depreciation recapture, and why is it such a big number when I sell?
Every year you own a rental building, the tax code lets you deduct a slice of its cost: residential improvements depreciate over 27.5 years, straight-line. When you sell, the IRS takes those deductions back: the accumulated depreciation is taxed at up to 25% federally (plus California ordinary rates), separate from and on top of the capital-gains rate on the rest of your profit. On a building held twenty-plus years, recapture alone can run into the hundreds of thousands. A 1031 exchange defers it; dying with the building erases it; ignoring it just makes it a surprise.
Answered by Shaya Lowenstein, a Los Angeles multifamily broker at Lyon Stahl Investment Real Estate, CA DRE 01942326, with 15 years in apartment buildings and land across Los Angeles County. His closed sales are published with addresses and recording dates, so anything claimed here can be checked against the county record.
How the number quietly gets huge.
Take a building bought for $2M with $1.4M allocated to improvements (land never depreciates). Straight-line over 27.5 years is about $51,000 a year in deductions, money that sheltered your rental income annually. Hold twenty years and you have taken roughly $1M in depreciation, which means your basis has dropped by $1M and every one of those dollars comes back as "unrecaptured Section 1250 gain" at sale, taxed at up to 25% federal plus up to 13.3% in California plus possibly the 3.8% NIIT. That is potentially $350,000-$400,000 of tax attributable to recapture alone, before the ordinary capital gain on the appreciation is even counted. The deduction was never free money; it was a loan from the IRS with the balloon due at closing.
The three ways out.
A 1031 exchange defers recapture right along with the capital gain: your old basis carries into the replacement property and the clock keeps running, which is why serial exchangers can defer for decades. Holding until death eliminates it: the step-up in basis resets everything, and the deferred recapture simply vanishes for your heirs, and the "swap till you drop" strategy is built on exactly this. An installment sale can spread the recognition of straight-line recapture across the years you receive payments, smoothing brackets. What does not work is pretending it away: sellers who model their tax bill at 15-20% on the whole gain and skip the 25% layer on a third of it are the ones who call their CPA in April sounding wounded.
EDUCATIONAL ONLY, NOT LEGAL OR TAX ADVICE. RATES, THRESHOLDS AND ORDINANCES CHANGE, AND SEVERAL OF THE FIGURES HERE DEPEND ON FACTS SPECIFIC TO YOU. CONFIRM ANYTHING YOU PLAN TO ACT ON WITH YOUR OWN ATTORNEY OR CPA, OR WITH THE AGENCY THAT SETS IT.
Do I owe recapture if I never actually claimed the depreciation?
Yes. The rule is depreciation "allowed or allowable," so the IRS reduces your basis whether you took the deduction or not. Not claiming it is the worst of both worlds; talk to a CPA about catching up before you sell.
Is the recapture rate always exactly 25%?
Up to 25% federally for straight-line depreciation on real property, and it can be lower if your ordinary bracket is lower. California adds its ordinary rates on top, and higher earners add the 3.8% NIIT.
Does a 1031 exchange eliminate recapture or just delay it?
It defers it. The liability carries into the replacement property. It only disappears if you hold until death and your heirs receive the step-up in basis.
SHAYA LOWENSTEIN · LYON STAHL INVESTMENT REAL ESTATE · DRE #01942326 · (323) 944-2221