What Depreciation Recapture Actually Is

When you own a rental property, the IRS lets you deduct the cost of the building (not the land) over its useful life — 27.5 years for residential rental property, 39 years for commercial. Those annual deductions reduce your taxable income each year. But when you sell the property, the IRS “recaptures” those deductions by taxing them as income.

The recapture amount is the lesser of your total accumulated depreciation or your gain on the sale. You don’t get to skip this just because you sold at a loss on the overall investment — if your adjusted basis (purchase price minus depreciation) is lower than the sale price, recapture applies even if the property sold for less than you originally paid.

This catches people off guard. You took the deductions to save money on taxes. Now the IRS takes a cut of those savings back. The math is mandatory whether you claimed the depreciation or not — the IRS calculates recapture based on depreciation you were allowed to take, even if you forgot to.

Federal Recapture: Section 1250 at 25%

Under Section 1250 of the Internal Revenue Code, depreciation recapture on real property is taxed at a maximum federal rate of 25%. This applies to the “unrecaptured Section 1250 gain” — the portion of your gain attributable to depreciation deductions taken in prior years.

Any gain above the depreciation amount gets taxed at regular long-term capital gains rates (0%, 15%, or 20% depending on your income). High earners also pay the 3.8% net investment income tax (NIIT) on both the recapture and capital gain portions.

A quick example: you bought a NYC apartment building for $2 million (building value $1.6 million, land $400,000). Over 10 years, you claimed $581,818 in depreciation. You sell for $2.8 million. Your adjusted basis is $1,418,182 ($2M minus $581,818 in depreciation). Total gain: $1,381,818. Of that, $581,818 is depreciation recapture taxed at 25% ($145,455 federal tax). The remaining $800,000 is long-term capital gain at 20% ($160,000). Plus NIIT at 3.8% on the full $1,381,818 ($52,509). Federal total: roughly $358,000.

New York State Taxes Recapture at Ordinary Rates

Here’s what makes New York different from the federal system: New York State does not have a separate, lower rate for depreciation recapture. It’s taxed as ordinary income. The top New York State income tax rate is 10.9% for income over $25 million (the rate at $1 million+ is 10.3%).

For the property sale in the example above, the $581,818 in recapture income gets added to your other New York taxable income for the year. If you’re already in a high bracket from salary or business income, the recapture pushes that income into the top marginal rates.

New York City residents face an additional income tax of up to 3.876% on the same income. There’s no special rate for capital gains or recapture at the city level either — it’s all ordinary income.

Running the numbers: on $581,818 of recapture, New York State tax at 10.3% is roughly $59,927. NYC tax at 3.876% adds about $22,542. Combined state and city tax on just the recapture portion: approximately $82,469. Add the federal $145,455 and you’re looking at over $227,000 in taxes on the depreciation recapture alone.

Strategies to Reduce or Defer Recapture in NYC

You can’t eliminate depreciation recapture entirely, but there are ways to manage the timing and impact.

• 1031 exchanges — swap one investment property for another of equal or greater value and defer both capital gains and depreciation recapture. The recapture doesn’t disappear; it carries forward into the replacement property. But deferral for 10 or 20 years has real value, especially in a high-tax state like New York
• Installment sales — spreading the gain over multiple tax years can keep you in lower brackets for both federal and state purposes. Under Section 453, you report gain proportionally as you receive payments. However, depreciation recapture must be recognized in the year of sale regardless of installment treatment
• Opportunity zone reinvestment — investing capital gains into a qualified opportunity zone fund within 180 days defers the gain. Some areas of the Bronx, Brooklyn, and Upper Manhattan are designated opportunity zones
• Cost segregation adjustments — if prior cost segregation studies accelerated depreciation, the recapture amount will be larger. This is a trade-off worth modeling before selling
• Charitable planning — donating appreciated property to a charitable remainder trust can avoid recapture entirely, though this approach requires giving up control of the property

The Installment Sale Trap for Recapture

This trips up a lot of sellers: even though installment sales let you spread capital gain recognition over the payment period, depreciation recapture is accelerated. You recognize the entire recapture amount in the year of sale, regardless of how much cash you received that year. If you sold a $3 million property on a 10-year installment note and have $700,000 in depreciation recapture, that $700,000 hits your tax return in year one. Plan your cash flow accordingly.

Bonus Depreciation and Cost Segregation Implications

If you used a cost segregation study to accelerate depreciation — reclassifying portions of a building as 5-, 7-, or 15-year property and claiming bonus depreciation — the recapture picture changes. Section 1245 recapture (for personal property components like appliances, carpeting, certain fixtures) is taxed at ordinary federal rates, not the 25% Section 1250 rate. In New York, the distinction barely matters since the state taxes everything at ordinary rates anyway. But federally, accelerated components recaptured under Section 1245 could be taxed at 37% instead of 25%.

The lesson: cost segregation saves real money in the years you hold the property. When you sell, some of that benefit comes back. The net is almost always positive, but you should model the exit before assuming the total savings.