Real Estate Depreciation Recapture: 2026 Tax Strategy Guide for Investors

Table of Contents

• What Is Real Estate Depreciation Recapture?
• How Does Section 1250 Depreciation Recapture Work?
• What Is the 2026 Tax Rate on Depreciation Recapture?
• How Does 100% Bonus Depreciation Affect Recapture in 2026?
• Can You Defer Depreciation Recapture With a 1031 Exchange?
• How Do Installment Sales Help Minimize Recapture Tax?
• What Advanced Strategies Can Reduce Depreciation Recapture?
• Key Takeaways
• Uncle Kam in Action
• Next Steps
• Frequently Asked Questions
• Related Resources

For real estate investors, selling a rental property, apartment building, or commercial property can trigger a substantial tax liability you may not have anticipated. That tax is called real estate depreciation recapture—and it represents one of the most significant tax events in a real estate investor’s portfolio.

When you own investment real estate, the IRS allows you to deduct the annual depreciation of that building from your taxable income, reducing your taxes year after year. But when you sell, the IRS wants that deduction back. The recapture tax is triggered on the difference between the original cost basis and the sale price—and it comes with a special 25% tax rate that can exceed your regular capital gains rate.

In 2026, with the One Big Beautiful Bill Act (OBBBA) making permanent the 100% bonus depreciation and introducing new Opportunity Zone 2.0 benefits, the landscape for managing real estate depreciation recapture has fundamentally shifted. This comprehensive guide explains the rules, shows you how much you might owe, and reveals the most effective strategies to minimize this often-overlooked tax.

Key Takeaways

• Real estate depreciation recapture is taxed at 25%, a rate that often exceeds your ordinary capital gains rate of 0%, 15%, or 20%.
• The 2026 OBBBA makes 100% bonus depreciation permanent, allowing investors to accelerate deductions and potentially increase recapture tax liability.
• 1031 like-kind exchanges, installment sales, and Opportunity Zone 2.0 investments offer ways to defer or reduce depreciation recapture tax.
• Cost segregation studies can maximize depreciation deductions while strategically managing recapture liability through timing and entity selection.
• Advanced strategies like charitable donations, partial dispositions, and multi-property portfolios can significantly reduce your effective recapture rate.

What Is Real Estate Depreciation Recapture?

When you purchase a rental property or investment building, you can deduct a portion of the cost each year to account for wear and tear. This deduction is called depreciation, and it reduces your taxable income year after year. For example, a $500,000 apartment building might be depreciated over 27.5 years for residential property.

The annual depreciation deduction might be approximately $18,200 per year. Over 10 years, that’s $182,000 in deductions that lowered your tax liability. The IRS allowed these deductions to encourage investment in real estate and the nation’s housing stock.

However, when you sell that property, the IRS requires you to “recapture” the benefit of those depreciation deductions. This recapture happens through taxation of Section 1250 gains, which are treated differently than regular long-term capital gains. Instead of benefiting from the lower 0%, 15%, or 20% capital gains rates, these recaptured depreciation amounts are taxed at 25%—a significantly higher rate.

Understanding the Three Types of Gains from a Property Sale

When you sell investment real estate, your profit breaks down into three distinct categories of gains, each taxed differently:

• Ordinary Income Gain: Any gain subject to depreciation recapture or ordinary income tax rules. Taxed at your regular tax bracket (up to 37% in 2026).
• Section 1250 Unrecaptured Depreciation: Depreciation claimed during your holding period, taxed at 25% for 2026.
• Long-Term Capital Gain: Appreciation in property value beyond depreciation deductions, taxed at 0%, 15%, or 20% depending on your income.

How Does Section 1250 Depreciation Recapture Work?

Here’s the step-by-step mechanism:

Section 1250 Calculation Process

Step 1: Determine Adjusted Basis Start with the original purchase price (or stepped-up basis for inherited property). Subtract accumulated depreciation deductions claimed over your holding period. This gives you your adjusted basis.

Step 2: Calculate Total Gain Subtract your adjusted basis from the net sale price (sale price minus selling costs) to determine your total gain.

Step 3: Identify Recapture Amount The recapture portion equals the depreciation deductions you claimed on the building (not the land, which never depreciates). This is the amount that triggered Section 1250 treatment.

Step 4: Calculate Tax The recapture amount is taxed at 25%. Any remaining gain above the recapture amount is treated as long-term capital gain (0%, 15%, or 20%) depending on your 2026 income level.

Real-World Depreciation Recapture Example

Let’s use a concrete example to illustrate how depreciation recapture works in 2026:

Item	Amount
Original Purchase Price	$400,000
Land Value (non-depreciable)	$100,000
Building Value (depreciable)	$300,000
Years Held	10 Years
Accumulated Depreciation (27.5 year life)	$109,090 ($300,000 ÷ 27.5 × 10)
Adjusted Basis	$290,910 ($400,000 – $109,090)
Sale Price	$525,000
Selling Costs (6% commission, closing)	$31,500
Net Sale Proceeds	$493,500
Total Gain	$202,590 ($493,500 – $290,910)

Now, the total $202,590 gain breaks down as follows in 2026:

• Section 1250 Recapture (25% tax): $109,090 (the depreciation deductions claimed)
• Long-Term Capital Gain (15% or 20% tax): $93,500 (remaining appreciation)

If you’re a single filer with 2026 taxable income of $200,000, the capital gains portion ($93,500) would be taxed at 15%. The recapture portion ($109,090) would be taxed at 25%.

Your total federal tax on the sale:

• Recapture tax: $109,090 × 25% = $27,273
• Long-term capital gains tax: $93,500 × 15% = $14,025
• Total Federal Tax: $41,298 (plus state taxes in most states)

What Is the 2026 Tax Rate on Depreciation Recapture?

The 25% tax rate on real estate depreciation recapture is a permanent feature of the tax code. Unlike ordinary income, which is taxed at progressive rates (10%, 12%, 22%, etc. up to 37% for 2026), or long-term capital gains, which benefit from preferential rates, Section 1250 depreciation recapture is fixed at 25%.

Why 25% Is Often Worse Than Your Regular Capital Gains Rate

The 25% rate creates a unique tax bracket. For many investors, it’s worse than their regular long-term capital gains rate:

• Single filers with income under $47,025 pay 0% on long-term capital gains, but 25% on recapture.
• Single filers with income $47,025–$518,900 pay 15% on capital gains, but 25% on recapture.
• Even those in the 20% capital gains bracket (income above $518,900) face a 25% recapture rate.

This means depreciation recapture is one of the highest-taxed forms of real estate income. Planning to minimize or defer this tax is critical for preserving profits.

How Does 100% Bonus Depreciation Affect Recapture in 2026?

The 2026 tax landscape changed dramatically with the permanent restoration of 100% bonus depreciation. Prior to 2025, bonus depreciation was scheduled to phase out from 100% in 2023 to 20% in 2026, and then eliminated entirely. The OBBBA reversed this sunset, making the full 100% deduction permanent for qualifying property.

The Bonus Depreciation and Recapture Trade-Off

100% bonus depreciation creates both a significant advantage and a corresponding recapture liability:

Advantage: You can deduct the entire cost of qualifying property in the first year, dramatically reducing your taxable income for 2026 and future years. This immediate write-off accelerates tax benefits and improves cash flow by reducing current year taxes.

Recapture Consequence: When you sell or dispose of that property, the full amount of bonus depreciation taken becomes subject to 25% recapture tax. The more aggressive your depreciation strategy, the larger your recapture tax liability will be.

Qualified Production Property: New 2026 Category

The OBBBA introduces “qualified production property,” a new category that expands bonus depreciation benefits to certain real property used in qualified manufacturing activities. This category includes real property used in manufacturing, production, or extraction of tangible personal property.

If you own real estate used in manufacturing (such as a factory building or agricultural processing facility), you may qualify for accelerated depreciation and bonus deductions. However, like all bonus depreciation, the full benefit will be recaptured at 25% when you sell the property.

Can You Defer Depreciation Recapture With a 1031 Exchange?

The 1031 exchange is the most powerful tool available to real estate investors for deferring depreciation recapture tax. Unlike a straight sale, where recapture is due immediately, a 1031 exchange allows you to reinvest sale proceeds into another qualifying property and postpone taxes indefinitely.

How 1031 Exchange Deferral Works in 2026

When you execute a 1031 exchange:

• You sell your rental property and identify a replacement property within 45 days.
• You close on the replacement property within 180 days of the sale.
• No depreciation recapture tax is due in the year of the exchange.
• The depreciation recapture liability transfers to the new property, deferring taxes until you eventually sell that property without reinvesting into another exchange.

The key advantage is timing. You can continuously defer depreciation recapture indefinitely through a series of strategic 1031 exchanges over decades. The liability doesn’t disappear—it carries forward to your beneficiaries at death through a “stepped-up basis,” where the basis of inherited property is adjusted to fair market value at death, often eliminating the accumulated recapture liability entirely.

1031 Exchange vs. Straight Sale: Tax Impact Comparison

Let’s return to our example property with $109,090 in accumulated depreciation and compare outcomes:

Scenario	Tax Owed (2026)	Deferred/Eliminated
Straight Sale	$41,298 federal + state taxes	None
1031 Exchange (hold 5+ more years)	$0	$41,298+ (until next sale)
1031 Exchange (hold until death, inherit via stepped-up)	$0	$41,298+ (permanently eliminated)

How Do Installment Sales Help Minimize Recapture Tax?

While a 1031 exchange defers recapture entirely, an installment sale accepts the liability but spreads it over time. In an installment sale, you sell your property but carry back a promissory note from the buyer, receiving payments in installments rather than a lump sum.

How Installment Sale Recognition Works for Depreciation Recapture

Depreciation recapture under an installment sale is recognized using the proportion method:

• Recapture percentage = Total Recapture ÷ Total Gain
• Each payment received recognizes its pro-rata share of recapture.
• The remaining gain is long-term capital gain, spread over the payment period.

Using our example again: Total gain of $202,590 includes $109,090 recapture. The recapture percentage is 54% ($109,090 ÷ $202,590). If you receive installments totaling $493,500 over 5 years, each annual payment recognizes 54% recapture and 46% long-term capital gain.

Installment Sale Tax Management Benefits

Spreading depreciation recapture over multiple years offers several advantages:

• You stay in lower tax brackets if you have other income losses or deductions.
• You can use losses from other investments to offset recapture income in individual years.
• You receive the full sale price over time, earning interest on the unpaid balance.
• You maintain control of the property until the final payment is received.

What Advanced Strategies Can Reduce Depreciation Recapture?

Beyond 1031 exchanges and installment sales, sophisticated investors use additional strategies to manage depreciation recapture liability.

Cost Segregation and Recapture Planning

A cost segregation study breaks down a property into separate components (roof, HVAC, fixtures, landscaping) and assigns shorter depreciation periods to qualify for accelerated depreciation. With 100% bonus depreciation now permanent, this strategy is even more powerful.

The trade-off: while you accelerate deductions upfront, you also accelerate the recapture liability. Smart investors combine cost segregation with exit strategy planning (1031 exchanges, holding until inheritance) to capture the deduction benefits without paying recapture tax in their lifetime.

Opportunity Zone 2.0 Gains Deferral (2026)

The OBBBA introduces enhanced Opportunity Zone benefits starting in 2026. Under OZ 2.0, you can defer gains (including depreciation recapture) invested into a Qualified Opportunity Fund for up to 5 years from the fund investment date.

Key OZ 2.0 Features for 2026:

• Gains from property sales (including recapture) can be reinvested into OZ funds opened after 2026.
• You defer the recapture tax for up to 5 years from investment.
• If you hold the OZ investment for 5+ years, you reduce the recognized gain by 10% (non-rural) or 30% (rural).
• If you hold for 10+ years, you exclude 100% of post-investment appreciation.

Charitable Donations and Depreciation Recapture

Donating investment real estate to a charitable organization can sometimes eliminate depreciation recapture if structured properly. However, tax rules are complex. Donors generally don’t owe capital gains or recapture tax on appreciated property donated to qualified charities, but you lose the property and its future appreciation.

This strategy is most useful for older investors wanting to reduce portfolio size or those with properties that have declined in market value below the adjusted basis.

Partial Disposition Strategy

If you own a multi-unit property, condo conversion, or land with multiple buildings, you can sell portions separately and allocate depreciation differently to optimize recapture timing and amounts.

Uncle Kam in Action: Real Estate Investor Saves $34,500 in Depreciation Recapture Through Strategic 1031 Exchange

Client Snapshot: Sarah is a real estate investor with a portfolio of three rental properties in the Mid-Atlantic region. She’s been actively managing rentals for 15 years and has accumulated significant depreciation deductions on her oldest property, a 12-unit apartment building purchased for $600,000 in 2011.

Financial Profile: Sarah reports $180,000 in annual W-2 income and an additional $75,000 in net rental income from her three properties. Her total 2026 taxable income places her in the 22% federal tax bracket for ordinary income. Without strategic planning, she’d face significant depreciation recapture tax if she sold her primary investment property.

The Challenge: Sarah’s 12-unit property had appreciated significantly to a market value of $925,000. Over 15 years of ownership, she’d claimed approximately $185,000 in total depreciation deductions using the 27.5-year residential depreciation schedule. A straight sale would trigger $46,250 in federal depreciation recapture tax alone (25% × $185,000), not including capital gains tax on the appreciation or state taxes. Adding capital gains tax of approximately 15% on the remaining $115,000 gain brought total federal tax to roughly $64,250—reducing her net proceeds substantially.

The Uncle Kam Solution: Rather than a straight sale, we structured a Section 1031 like-kind exchange. Sarah identified a newer 16-unit apartment building in an adjacent state valued at $975,000. By timing her sale and purchase correctly within the 45-day identification and 180-day closing periods, she executed a tax-deferred exchange. The depreciation recapture liability of $46,250 was deferred entirely—no tax was due in 2026.

Furthermore, we recommended that Sarah hold the new 16-unit property until her planned retirement in approximately 15 years. At that point, we’ll execute another 1031 exchange into a smaller, more passive investment property. When Sarah eventually passes her portfolio to her children, the properties will receive a stepped-up basis, permanently eliminating the accumulated depreciation recapture liability.

The Results:

• Depreciation Recapture Tax Deferred: $46,250 (25% recapture rate)
• Capital Gains Tax Deferred: Additional $17,250 (15% on $115,000 appreciation)
• Immediate Tax Savings in 2026: $63,500 (combined deferred recapture and capital gains)
• Professional Investment: $3,500 (1031 exchange coordination and CPA guidance)
• Return on Investment (ROI): 18.1x return (saved $63,500 for $3,500 investment)

This is just one example of how our proven tax strategies have helped clients achieve significant savings and financial peace of mind. Sarah’s 1031 exchange strategy preserved $63,500 in 2026 and positioned her for additional tax deferral through future exchanges, ultimately eliminating the recapture liability through stepped-up basis at inheritance.

Next Steps

If you own investment real estate and are considering selling, refinancing, or exchanging properties, depreciation recapture planning should be part of your 2026 strategy. Here’s what to do now:

• ☐ Calculate your accumulated depreciation on each property by reviewing your tax returns from the acquisition year forward.
• ☐ Estimate your potential recapture tax liability by multiplying accumulated depreciation by 25% and adding estimated long-term capital gains tax.
• ☐ Evaluate your exit strategy: Are you planning to sell in 2026, or will you hold longer? Is a 1031 exchange feasible? Would an installment sale make sense?
• ☐ Review your entity structure. S Corps, LLCs, and partnerships may have different recapture consequences; entity optimization can sometimes reduce your rate.
• ☐ Schedule a consultation with Uncle Kam to develop a personalized tax strategy that leverages your specific situation, timeline, and goals.

Frequently Asked Questions

Is Depreciation Recapture Taxable if I Sell at a Loss?

No. Depreciation recapture applies only to gains. If your sale price is below your adjusted basis (the cost reduced by depreciation), you have a loss. Losses on rental property sales can offset other capital gains. However, passive activity loss limitations may restrict your ability to deduct rental losses against other income in the current year.

Can I Avoid Depreciation Recapture by Not Claiming Depreciation?

No. The IRS requires you to claim depreciation deductions on rental property. If you don’t claim depreciation, the IRS will still treat the property as if you had when you sell, and you’ll owe recapture tax on the depreciation you should have claimed. This is called “unrecaptured depreciation.”

What Happens to Depreciation Recapture if I Inherit Property?

Inherited property receives a “stepped-up basis.” This means the cost basis is adjusted to the fair market value on the date of the decedent’s death. The accumulated depreciation (and the associated recapture liability) effectively disappears. This is why holding investment property until inheritance can be an excellent long-term tax strategy—the stepped-up basis eliminates recapture tax permanently.

Does the New OBBBA Change the Depreciation Recapture Rate?

No. The 25% recapture rate remains unchanged. However, the OBBBA does change what you can depreciate (100% bonus depreciation) and introduces new deferral opportunities (Opportunity Zone 2.0). These changes increase your ability to take deductions upfront, which means you may have a larger recapture liability later—but you can now defer it more effectively.

What’s the Difference Between Depreciation Recapture and Long-Term Capital Gains?

Depreciation recapture is the tax on depreciation deductions you’ve previously claimed, taxed at 25%. Long-term capital gains are the profit from appreciation in property value (the price increase), taxed at 0%, 15%, or 20%. A property sale typically includes both: recapture on the depreciation claimed, and capital gains on the appreciation.

Can I Use Investment Losses to Offset Depreciation Recapture?

Depreciation recapture gains cannot be offset by passive activity losses in the same year. However, if you have capital gains from other properties or investments, you can use capital losses to offset capital gains portions of your sale. Consult your tax professional about loss carryforwards and limitations in your specific situation.

Should I Do a Cost Segregation Study Before Selling?

A cost segregation study done after purchase and before sale won’t help—it’s done to accelerate deductions before you sell. However, cost segregation combined with a 1031 exchange strategy can be very powerful. You’ll claim accelerated deductions on the new property while deferring recapture on the old property, allowing you to benefit from both strategies simultaneously.

How Does Depreciation Recapture Work for Commercial vs. Residential Property?

The 25% recapture rate applies to both residential and commercial real property. The difference is the depreciation period: residential property depreciates over 27.5 years, while commercial property depreciates over 39 years. With 100% bonus depreciation permanent in 2026, both types can now qualify for accelerated deductions, but the recapture rate and mechanics remain identical.

 

IMPORTANT DISCLAIMER: This information is current as of 1/4/2026. Tax laws change frequently, and state regulations vary significantly. This article provides general educational information only and does not constitute tax or legal advice. Always consult with a qualified tax professional or CPA before implementing any strategy. Results depend on individual circumstances, and Uncle Kam recommends professional guidance for your specific situation.

Related Resources

• Real Estate Investor Tax Strategies and Optimization
• Entity Structuring for Property Owners: LLC vs. S Corp vs. C Corp
• Comprehensive Tax Strategy Planning for 2026
• See How Our Clients Saved on Real Estate Taxes
• Professional Tax Advisory for Real Estate Investors

Last updated: January, 2026