Capital Gains vs. Depreciation Recapture: What You Need to Know

When selling an investment property, most investors focus on capital gains taxes — the profit earned from the sale. However, there’s another tax that often catches investors off guard: depreciation recapture. Understanding both is essential when planning a 1031 exchange.

 Capital Gains Tax

Capital gains are the profits made when you sell a property for more than your original purchase price. If you’ve held the property for more than a year, you’ll typically pay long-term capital gains tax, which ranges from 0% to 20%, depending on your income bracket.

 Depreciation Recapture

Depreciation recapture is the IRS’s way of “clawing back” the tax benefits you received from depreciation deductions during ownership. When you sell, the IRS taxes this portion — up to 25% — even if the property has appreciated in value.

For example:

If you depreciated $200,000 over time, and you sell the property, you could owe up to $50,000 (25% of $200,000) in depreciation recapture tax.

 How a 1031 Exchange Helps

A 1031 exchange allows you to defer both capital gains and depreciation recapture taxes — as long as you reinvest all proceeds into another like-kind property. By doing so, you keep your capital working for you instead of paying a large tax bill immediately.

While capital gains get most of the attention, depreciation recapture can significantly impact your net proceeds. A well-structured 1031 exchange can defer both, allowing your equity to continue growing tax-deferred.

 Thinking of selling an investment property? Learn how a 1031 exchange can help you preserve more of your profits — and reduce your tax exposure.