Depreciation Recapture on Rental Property: 25% Rate and 1031
When you sell a rental building at a gain, the part of the gain equal to the depreciation you took (or could have taken) is “unrecaptured section 1250 gain,” taxed at your ordinary rate but never more than 25% (IRC §1(h)(1)(E)). Cost-segregated components classified as §1245 property are recaptured as ordinary income, at rates up to 37%. The 3.8% net investment income tax can apply on top. A 1031 exchange defers all of it into the replacement property.
Unrecaptured section 1250 gain
§1(h)(6) defines it as the long-term gain that would be ordinary income if §1250 recaptured all depreciation at 100%. In plain terms: the gain up to the amount of depreciation on the building, to the extent it isn’t already ordinary income under §1250 itself.
For a building depreciated straight-line and held more than a year, §1250 itself recaptures nothing, because it only reaches “additional depreciation,” meaning depreciation in excess of straight-line (§1250(b)(1)). So all the depreciation shows up in the 25% bucket instead.
The 25% is a ceiling. The statute taxes this gain at regular rates where it falls in brackets below 25%, so a taxpayer in the 22% or 24% bracket pays those rates on it. Schedule D’s worksheet starts from the smaller of the depreciation and the total gain on Form 4797.
Allowed or allowable: depreciation you skipped still counts
§1016(a)(2) reduces basis by depreciation “allowed as deductions” but “not less than the amount allowable.” If you never claimed depreciation on a rental, your basis still drops as if you had, and the gain on sale is larger. The deduction you skipped doesn’t come back on its own; your CPA can tell you whether an accounting-method change is available to catch it up.
Section 1245 recapture on cost-segregated property
A cost segregation study reclassifies parts of a building (some fixtures, finishes, site improvements and similar items) into shorter-lived property, including §1245 property. On a sale, §1245(a)(1) treats gain on those components as ordinary income up to the depreciation taken, measured against the lower of recomputed basis or amount realized. That’s taxed at ordinary rates, not capped at 25%.
These components can be real property for §1031 purposes and still §1245 property for recapture. Reg. §1.1031(a)-3(a)(7) says so expressly: “a structure or a portion of a structure may be section 1245 property for depreciation purposes and for determining gain under section 1245” even when it is real property under the 1031 definition.
Net investment income tax on top
Gain on rental real estate is generally net investment income. The NIIT is 3.8% of the lesser of net investment income or modified AGI above $250,000 (married filing jointly), $125,000 (married filing separately) or $200,000 (others) (§1411). Those thresholds are not indexed. An exception applies to property used in a non-passive trade or business, such as by a qualifying real estate professional who materially participates (Form 8960 instructions).
Worked example, 2026 rates
Illustrative numbers. A married couple filing jointly sells a rental in 2026.
- Purchase price years ago: $1,000,000, of which $200,000 was land
- Depreciation taken on the building, all straight-line: $250,000
- Adjusted basis: $750,000
- Sale price, net of selling costs: $1,400,000
- Gain: $650,000, all long-term
- Their other taxable income for 2026: $500,000, all ordinary
Split the gain:
| Piece | Amount | Rule |
|---|---|---|
| Unrecaptured §1250 gain | $250,000 | Smaller of depreciation ($250,000) and gain ($650,000) |
| Other long-term gain | $400,000 | The rest |
Total taxable income is $1,150,000. Under §1(h), the 0/15/20% rates apply to the other long-term gain counted last, on top of ordinary income and the unrecaptured §1250 gain; the Schedule D Tax Worksheet stacks it the same way. Using the 2026 brackets in Rev. Proc. 2025-32, where the 15% capital gain rate stops at $613,700 of taxable income for joint filers:
| Layer | Taxable income range | Amount | Rate | Tax |
|---|---|---|---|---|
| Unrecaptured §1250 gain | $500,000 to $750,000 | $250,000 | 25% | $62,500 |
| Other long-term gain | $750,000 to $1,150,000 | $400,000 | 20% | $80,000 |
| NIIT | $650,000 | 3.8% | $24,700 | |
| Federal tax on the sale | $167,200 |
The §1250 layer sits where ordinary rates would be 32% and 35% for joint filers in 2026, so the cap holds it at 25%. The other gain starts above $613,700, so none of it gets the 15% rate. NIIT is 3.8% of the lesser of the $650,000 of net investment income or MAGI above $250,000; MAGI here is at least $1,150,000, which is $900,000 or more over the threshold, so the full $650,000 is taxed. State tax is extra.
If the same couple had cost-segregated the building and $60,000 of the depreciation had been on §1245 components, that $60,000 would be ordinary income at their marginal rate instead, and the unrecaptured §1250 amount would shrink accordingly. You can model a sale like this in the capital gains tax calculator.
How a 1031 exchange defers recapture
In a full 1031 exchange with no boot, none of the $650,000 is recognized. The replacement property takes a carryover basis under §1031(d): your old $750,000 basis, adjusted for cash and debt in the exchange. The depreciation doesn’t disappear. §1250(b)(3) counts depreciation “whether in respect of the same or other property” reflected in the adjusted basis, so the history follows the carryover basis into the new building. When you later sell the replacement in a taxable sale, the earlier depreciation is part of the recapture calculation.
Boot is taxed in the exchange year, and on depreciated property it’s likely to come out as unrecaptured §1250 gain first. That ordering is an inference from the statute, not an IRS-stated rule. See boot in a 1031 exchange.
Section 1245 recapture can apply even in an exchange with little or no boot. Under §1245(b)(4), the recapture is limited to gain recognized plus the fair market value of property received that is not §1245 property. When you trade a cost-segregated building for a building with little or no §1245 property, that limit can be large, and Form 8824 line 21 can show ordinary income greater than your boot. The Form 8824 instructions work an example: a seller gives up $55,000 of §1245 property with a $35,000 depreciable basis, receives only §1250 property plus $40,000 of cash, and reports $35,000 of §1245 ordinary income on line 21.
Stepped-up basis at death
Under current law, property you hold until death generally takes a basis in your heirs’ hands equal to fair market value at the date of death (§1014(a)). Both §1245(b)(2) and §1250(d)(2) say recapture doesn’t apply to a transfer at death, except for income in respect of a decedent under §691. So gain deferred through one or more exchanges, including the depreciation inside it, is not reflected in the heir’s basis. Estate tax is a separate question, and this rule can change with legislation.
The rates and brackets above are 2026 federal figures. Have a CPA run them against your own return before you decide.
Sources
- 26 U.S.C. §1(h)
- 26 U.S.C. §1016
- 26 U.S.C. §1245
- 26 U.S.C. §1250
- 26 U.S.C. §1014
- 26 U.S.C. §1411
- 26 U.S.C. §1031
- Treas. Reg. §1.1031(a)-3
- Rev. Proc. 2025-32 (2026 inflation adjustments)
- Instructions for Schedule D (2025)
- Instructions for Form 8824 (2025)
- Instructions for Form 8960
- IRS: Questions and answers on the net investment income tax
Questions people ask
What is the depreciation recapture tax rate on rental property?
For a building depreciated straight-line, the gain attributable to depreciation is unrecaptured section 1250 gain, taxed at your ordinary rate but no more than 25%. Cost-segregated components that are section 1245 property are recaptured at ordinary rates, up to 37%.
Do I owe recapture on depreciation I never claimed?
Yes. Section 1016(a)(2) reduces basis by depreciation allowed, but not less than the amount allowable, so unclaimed depreciation still lowers your basis and raises your gain.
Does a 1031 exchange eliminate depreciation recapture?
No, it defers it. The replacement property takes a carryover basis, so the depreciation stays embedded in the gain. Recapture applies when you later sell in a taxable sale, though section 1245 recapture can apply in an exchange in some cases.
What happens to depreciation recapture at death?
Under current law, heirs generally take a basis equal to fair market value at the date of death (section 1014), and sections 1245 and 1250 do not apply to a transfer at death, apart from income in respect of a decedent.