Every year an investment property is depreciated on a tax return, the IRS is effectively lending the owner a deduction against ordinary income, and depreciation recapture is how that loan gets repaid at sale. It surprises owners more often than any other line item in a real estate closing, partly because it's calculated separately from capital gains and taxed at its own rate, and partly because it applies whether or not the depreciation actually reduced the owner's tax bill in prior years.
How the Calculation Actually Works
Recapture applies to the total depreciation claimed, or allowable, over the holding period on the building and any depreciable improvements, not on the land, which is never depreciated. For real property, that recaptured amount is taxed at a rate capped at 25 percent federally, sometimes called unrecaptured Section 1250 gain, distinct from the standard 0, 15, or 20 percent long-term capital gains rate applied to appreciation above the original basis.
A Concrete Example, Worked Through
Consider an owner who bought a Beaverton office building for $900,000, claimed $260,000 in depreciation over the holding period, and sells for $1.3M. The adjusted basis is $640,000 after subtracting depreciation, making the total gain $660,000. Of that, $260,000 is taxed as recapture at up to 25 percent federally, and the remaining $400,000 is taxed at standard long-term capital gains rates, with Oregon then taxing the full $660,000 combined as ordinary income at the state level.
Why It Applies Even If You Skipped Depreciation
The IRS calculates recapture based on depreciation "allowed or allowable," meaning an owner who never claimed depreciation on past returns, whether through an oversight or a decision to skip it, still owes recapture tax as if they had. This is one of the more counterintuitive aspects of the rule, and it means going back and amending prior returns to claim missed depreciation is often worthwhile before a sale, since it can improve depreciation-related deductions taken along the way without changing the recapture exposure at sale.
Deferring Recapture Through an Exchange
A 1031 exchange defers recapture along with the rest of the gain, since the replacement property inherits the relinquished property's basis rather than resetting it. This means the recapture liability doesn't disappear, it moves forward into the new property and becomes due whenever that property is eventually sold outright rather than exchanged again. For an owner planning to keep reinvesting in real estate for years, that deferral can be repeated indefinitely, though each exchange still requires a qualified intermediary and adherence to the identification and closing deadlines.
The Oregon Piece Most Sellers Forget to Add
Because Oregon doesn't separate recapture from ordinary capital gains for state tax purposes, the entire $660,000 in the example above is taxed at Oregon's regular income tax rates, up to roughly 9.9 percent, with no reduced rate the way federal law provides for the non-recapture portion. Sellers who estimate their tax bill using only the federal recapture and capital gains rates, without adding the Oregon state figure, routinely underestimate what they'll actually owe.
Building the Recapture Number Before Closing
A cost segregation study or a simple pull of prior depreciation schedules from tax returns is usually enough to arrive at an accurate recapture figure well before a sale closes, rather than waiting for the following year's return to reveal the total. Sellers weighing a straight sale against a 1031 exchange should have this number in hand early, since it's often the recapture portion, more than the appreciation itself, that tips the decision toward deferral for a property held many years.
Common 1031 Exchange Questions
What is depreciation recapture in simple terms?
It's the tax owed, when a property is sold, on the depreciation deductions claimed during ownership. It's calculated and taxed separately from the rest of the capital gain, at a rate capped at 25 percent federally.
Do I owe recapture tax if I never claimed depreciation on my property?
Generally yes. The IRS calculates recapture on depreciation you were allowed to claim, whether or not you actually claimed it, so skipping the deduction in prior years doesn't reduce the recapture bill at sale.
Is depreciation recapture taxed at the same rate as capital gains?
No. Recapture is capped at 25 percent federally and calculated separately from the standard 0, 15, or 20 percent long-term capital gains rate that applies to the remaining gain.
Can a 1031 exchange defer depreciation recapture tax?
Yes. A properly structured exchange defers recapture along with the rest of the gain, carrying the liability forward into the replacement property's basis rather than triggering it at the time of sale.
Does Oregon tax depreciation recapture differently than the IRS does?
Oregon doesn't use a separate recapture rate; it taxes the entire gain, recapture included, as ordinary income under the state's standard tax brackets, up to roughly 9.9 percent.
