How Depreciation Recapture Works When You Sell Commercial Real Estate

Understand how a portion of your profits from selling commercial property can be taxed at a special rate, impacting your after-tax returns.

By Garret Merkley · Explainer · Jun 16, 2026

Branched from Cost Segregation for Commercial Real Estate: When and How Much You Can Save

Quick take

Depreciation recapture taxes the depreciation deductions you've taken on commercial real estate when you sell it.
When you sell for a gain, the amount of profit equal to your total depreciation is taxed at a maximum 25% federal rate.
This "unrecaptured Section 1250 gain" significantly impacts your net profit from a sale.
It's a critical factor in financial planning for commercial real estate investors.

Depreciation recapture is a tax rule that requires you to pay back some of the tax benefits you received from deducting depreciation on a commercial property when you sell it for a profit. Essentially, if you sell a property for more than its depreciated value (its "adjusted basis"), the IRS "recaptures" the depreciation deductions you took over the years, taxing that portion of your gain at a special rate.

The Basics of Depreciation and Your Basis

When you own commercial real estate, the IRS allows you to deduct a portion of the building's value (excluding land) each year. This deduction, called depreciation, accounts for the property's wear and tear over time. Taking depreciation reduces your taxable income annually, which is a significant tax benefit for investors. As you take these deductions, your property's original cost basis is reduced, creating what's called its "adjusted basis."

How Recapture Happens at Sale

When you sell your commercial property, the IRS looks at your original purchase price, the total depreciation you've taken, and your selling price. Your taxable gain on the sale is the difference between the selling price (minus selling costs) and your adjusted basis. This gain is then split into two parts for tax purposes.

The portion of your gain that is equal to the total depreciation you've claimed over your ownership period is subject to depreciation recapture. This specific type of gain is referred to as "unrecaptured Section 1250 gain" and is taxed at a maximum federal rate of 25%. Any remaining gain above your original cost (after accounting for the depreciation taken) is then taxed at the standard long-term capital gains rates, which are typically lower than 25% for many investors.

Why It Matters for Commercial Real Estate Investors

Depreciation recapture significantly impacts the net profit you realize from selling a commercial property. While depreciation offers valuable tax savings during ownership, recapture means you don't get to keep all those savings when you sell. Understanding how it works is crucial for financial planning, evaluating potential returns, and making informed decisions about when and how to sell your investment properties. It applies whenever you sell a depreciated commercial property for a gain.

Example Scenario

**Original Purchase Price:** $1,000,000 (Building: $800,000, Land: $200,000)
**Total Depreciation Taken:** $200,000 over several years
**Adjusted Basis:** $1,000,000 - $200,000 = $800,000
**Selling Price:** $1,300,000
**Total Taxable Gain:** $1,300,000 - $800,000 (adjusted basis) = $500,000
**Depreciation Recapture (Unrecaptured Section 1250 Gain):** $200,000 (taxed at max 25%)
**Long-Term Capital Gain:** $500,000 - $200,000 = $300,000 (taxed at standard capital gains rates)

Does depreciation recapture apply if I sell my property at a loss?

No, depreciation recapture only applies when you sell a property for a gain. If you sell at a loss, there is no gain to recapture.

Can I avoid depreciation recapture?

You can defer depreciation recapture using a 1031 Exchange (like-kind exchange), which allows you to reinvest the proceeds from a sale into a similar property without immediately paying taxes on the gain, including the recaptured depreciation. However, this is a deferral, not an elimination, as the recaptured amount carries over to the new property.

What if I didn't take depreciation deductions, even though I could have?

The IRS generally assumes you took the depreciation you were entitled to, even if you didn't. When calculating your adjusted basis for the sale, your basis will still be reduced by the amount of depreciation you *could* have claimed, potentially leading to recapture even if you didn't personally benefit from the annual deductions.

Are there state taxes on depreciation recapture?

Yes, in addition to federal taxes, many states also have their own income taxes that may apply to depreciation recapture, further impacting your net proceeds from a sale.

Is depreciation recapture the same as capital gains tax?

No, they are distinct. Depreciation recapture is a specific type of gain taxed at a maximum federal rate of 25% (for unrecaptured Section 1250 gain). Any gain beyond the recaptured depreciation is then subject to the standard long-term capital gains tax rates, which can be 0%, 15%, or 20% depending on your income level.