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View serviceDepreciation Recapture Explained
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How depreciation recapture is taxed separately from capital gains on the sale of investment property, and how a 1031 exchange defers both.
Depreciation recapture is the portion of gain on the sale of investment real estate that is attributable to depreciation deductions claimed during ownership, and it is taxed differently than ordinary capital gain. For real property, the recaptured amount is called unrecaptured Section 1250 gain, and it is taxed at a federal rate of up to 25 percent, which is higher than the top 20 percent rate that applies to standard long term capital gains. This distinction often surprises Orange County investors who assume their entire gain will be taxed at the more favorable capital gains rate.
Depreciation recapture applies only to the straight line depreciation actually claimed, or that should have been claimed, on the property during the ownership period. Because commercial and residential rental buildings are depreciated over 39 years and 27.5 years respectively, an investor who has owned a property for a long time has typically claimed substantial depreciation, which both lowers the property's basis and increases the recapture exposure at sale. Land is not depreciable, so recapture only applies to the building and any depreciable improvements, not the underlying land value.
A Section 1031 exchange defers depreciation recapture along with the standard capital gain, as long as the exchange is properly structured and the replacement property is like-kind real property held for investment or business use. The deferred depreciation carries forward into the replacement property's basis, meaning the recapture liability is postponed rather than eliminated, and will resurface if the replacement property is eventually sold outright rather than exchanged again. Orange County investors with heavily depreciated properties should model recapture exposure carefully, since it can represent a substantial share of the total tax cost of an outright sale.
What Is Included
- Depreciation schedule review to quantify recapture exposure
- Separation of unrecaptured Section 1250 gain from standard capital gain
- Land versus building value allocation review
- Federal recapture tax exposure estimate
- Comparison of outright sale versus 1031 exchange recapture treatment
- Coordination with CPA on depreciation history documentation
- Explanation of how deferred recapture carries into replacement property basis
- Timeline planning if an exchange is selected to defer recapture
Common Situations
- Orange County investor with a heavily depreciated property evaluating the tax cost of a sale
- Owner surprised by recapture exposure after assuming the full gain would be taxed at capital gains rates
- Investor deciding whether to exchange again or accept recapture on a property acquired through a prior 1031 exchange
Frequently Asked Questions
What is depreciation recapture?
Depreciation recapture is the portion of gain on a property sale attributable to depreciation deductions claimed during ownership, taxed separately from standard capital gain.
What tax rate applies to depreciation recapture on real property?
Unrecaptured Section 1250 gain on real property is taxed at a federal rate of up to 25 percent, higher than the top 20 percent long term capital gains rate.
Does land depreciate and generate recapture exposure?
No, land is not depreciable, so depreciation recapture only applies to the building and depreciable improvements, not the underlying land value.
Can a 1031 exchange defer depreciation recapture?
Yes, a properly structured 1031 exchange defers depreciation recapture along with standard capital gain, carrying the liability forward into the replacement property's basis.
Does deferred recapture disappear after a 1031 exchange?
No, the recapture liability is postponed, not eliminated, and will resurface if the replacement property is later sold outright rather than exchanged again.
Why do long held properties often have larger recapture exposure?
Longer holding periods mean more years of depreciation claimed, which both lowers the property's basis and increases the amount of gain classified as recapture rather than standard capital gain.
Example of the type of engagement we can handle
Example Capability
Service type:
Depreciation Recapture Exposure Review
Location:
Orange County, CA
Scope:
Quantify unrecaptured Section 1250 gain on a Huntington Beach commercial building depreciated over twenty five years
Client situation:
Investor holding a Huntington Beach commercial building with a long depreciation history wanted to understand recapture exposure before deciding on a sale
Our approach:
Reviewed the full depreciation schedule, calculated unrecaptured Section 1250 gain separately from standard capital gain, estimated combined federal recapture and capital gains exposure, compared the result to a 1031 exchange scenario
Expected outcome:
Investor understood the recapture-driven tax cost of a sale and elected to pursue a 1031 exchange to defer both components
Contact us to discuss your situation in Orange County, CA. We can share references upon request.
Educational content only. Not tax, legal, or investment advice.
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Identification rules
Three Property Rule
Identify up to three candidate properties anywhere in the United States, regardless of value, within 45 days.
Two Hundred Percent Rule
Name more than three properties as long as the combined value stays within 200 percent of the relinquished sale price.
Ninety Five Percent Rule
If you exceed those limits, acquire at least 95 percent of the total value identified to keep the exchange compliant.
Identification letter helper
Identification Letter 7/21/2026 Qualified Intermediary, Please accept this written identification for my pending Section 1031 exchange in Newport Beach, CA. Replacement properties: 1) ____________________ 2) ____________________ 3) ____________________ I confirm these properties meet the like-kind and value requirements as of today. Signature ____________________
Timeline tracker
Day 0
Close relinquished property in Newport Beach, CA.
Day 15
Secure intermediary receipts and wire instructions.
Day 30
Begin physical and financial due diligence on preferred assets.
Day 45
Submit identification letter with up to three properties.
Day 90
Lock financing, finalize PSA adjustments, order closing docs.
Day 180
Complete closing with escrow and intermediary coordination.
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