Depreciation Recapture on a Rental Property: 25% Is a Cap, Not a Rate (2026 Worked Example From the Code and IRS Forms)

The layers the Code actually has

Searching “depreciation recapture” returns pages that treat it as one tax. The statute has several, and which one you owe depends on what you depreciated. Our plain-language map, each row tied to its section:

IRS Topic no. 704, the page most people reach first, was last reviewed on September 24, 2026 and says what depreciation is, which property qualifies and that the special depreciation allowance is now 100% for qualified property acquired and placed in service after January 19, 2025. It does not say what happens when you sell. For that you need the Code, the Form 4797 instructions and the Schedule D instructions, which is where the rest of this page comes from.

Why a plain rental building has no “section 1250 recapture”, and still has a 25% layer

The ordinary-income rule for real property, 26 U.S.C. 1250(a)(1)(A), reaches only “additional depreciation”, which section 1250(b)(1) defines as the depreciation adjustments that exceed what straight line would have produced. A building depreciated straight line has none. The Form 4797 instructions for 2025 spell it out: “Section 1250 recapture does not apply to dispositions of the following MACRS property placed in service after 1986”, and the list that follows is 27.5-year residential rental property and 22-, 31.5- or 39-year nonresidential real property. The same instructions say when it does apply: “Generally, section 1250 recapture applies if you used an accelerated depreciation method or you claimed any special depreciation allowance”. A 15-year land improvement depreciated with bonus is the kind of real property that can land there (our reading of sections 1250(b)(1) and 168(k)).

That does not make the depreciation free. Congress added a separate layer in section 1(h). Paragraph (6)(A) defines unrecaptured section 1250 gain as the long-term gain that would be ordinary income “if section 1250(b)(1) included all depreciation and the applicable percentage under section 1250(a) were 100 percent”, which in practice means the gain up to the depreciation you took. Paragraph (6)(B) limits the amount from business property to the net section 1231 gain for the year. Paragraph (1)(E) then taxes it at 25 percent of the excess of that gain over the amount by which taxable income without it, plus the net capital gain, exceeds taxable income. In words: the 25% applies only to the slice that would otherwise be taxed above 25%. A slice that fits in the 10%, 12%, 22% or 24% brackets is taxed at those rates. That is the part most guides skip.

The depreciation you are charged with: 27.5 or 39 years, “allowed or allowable”

Residential rental property has a 27.5-year recovery period and nonresidential real property 39 years (26 U.S.C. 168(c)). Publication 946 (2025) gives the mid-month straight-line percentages. A property placed in service in March gets 2.879% of the building basis in the first year on the 27.5-year table and 2.033% on the 39-year table; every full year after that is 3.636% or 2.564%:

Land is not in the base: IRS Topic no. 704 says “Land is never depreciable”, so the purchase price is split between land and building, and only the building generates the depreciation that later comes back as unrecaptured gain. Publication 946 adds that an improvement is its own asset: “If you improve depreciable property, you must treat the improvement as separate depreciable property.” A new roof or kitchen has its own clock and its own unrecaptured gain.

The phrase that decides the tax is “allowed or allowable”. Section 1016(a)(2) reduces your basis by the depreciation “allowed as deductions” and reducing your taxes, “but not less than the amount allowable under this subtitle or prior income tax laws.” Publication 946 puts it for landlords: “If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.” So a landlord who never took depreciation is taxed on the gain as if they had, without ever getting the deductions. The same publication says a taxpayer who files Form 3115 to fix the method can make a section 481(a) adjustment for any “unclaimed or excess amount of allowable depreciation”. Whether and how to use it is a question for a preparer, before the sale and not after.

Worked example: a rental bought in March 2016 and sold in March 2026

The property, dates, prices and income levels are hypothetical and marked “our assumption”; every rate, percentage and limit comes from the sources named. The depreciation base is the building only.

Depreciation by year. Table A-6, month 3, gives 2.879% for 2016, 3.636% for 2017 to 2024, 3.637% for 2025 and 3.636% for the year of sale. In the year of disposition the mid-month convention allows a fraction of a full year: Publication 946 says to multiply a full year of depreciation by a fraction whose numerator is the number of months, including partial months, the property is considered in service, over 12. For a March sale that is 2.5 months, as the publication treats the month of disposition as one-half month. Each year is rounded to the dollar (our rounding):

As a cross-check, 120 months in service is 10 years of 27.5, and $336,000 x 10 / 27.5 is $122,182 (our arithmetic); the $8 difference is the rounding built into the published percentages.

The gain, and how it splits. Adjusted basis is cost minus depreciation allowed: $420,000 minus $122,174, or $297,826. The gain is $564,000 minus $297,826, or $266,174. Because this is straight-line 27.5-year property, section 1250 ordinary recapture is $0. Unrecaptured section 1250 gain is the lesser of the gain or the depreciation: $122,174. The other $144,000 is ordinary long-term gain, which is also what you get from $600,000 minus $420,000 minus $36,000 (our arithmetic). We treat the sale as one gain; if the $564,000 is allocated 80/20 between building and land, the building’s own gain is $237,374, still above its $122,174 of depreciation, so the split does not change (our arithmetic).

What the 2026 brackets do to it

The 2026 numbers come from Rev. Proc. 2025-32. Joint-return brackets: 10% to $24,800, 12% to $100,800, 22% to $211,400, 24% to $403,550, 32% to $512,450, 35% to $768,700, then 37%. For long-term gain the 0% rate applies up to $98,900 of taxable income for joint filers ($49,450 for unmarried individuals and married filing separately, $66,200 for heads of household) and the 15% rate up to $613,700 ($545,500 for unmarried individuals, $579,600 for heads of household, $306,850 married filing separately).

We ran the sale through the Schedule D Tax Worksheet. The 2026 worksheet is not published, so we used the 2025 worksheet from the Instructions for Schedule D and replaced its three 2025 joint-filer constants ($96,700, $394,600 and $600,050) with the Rev. Proc. 2025-32 amounts for 2026 ($98,900, $403,550 and $613,700), an adaptation that is ours. Unrecaptured gain is stacked on top of your other taxable income, and the 0% and 15% gain sits on top of that. We assume a joint return, no other capital gains and, for the NIIT, MAGI equal to taxable income; real MAGI is usually higher, which would raise the NIIT. State tax is not included.

Three things follow, all our arithmetic from the worksheet. First, the 25% is reached only at the top. The unrecaptured gain is taxed at ordinary rates up to the top of the 24% bracket at $403,550, and only the part above that is taxed at 25%: $403,550 minus $122,174 is $281,376, so a joint filer with less other taxable income than that has some of it in a lower bracket (at $120,000, $91,400 at 22% and $30,774 at 24%). Second, the zero-rate gain does not help. The 0% limit of $98,900 is used up by ordinary income and the unrecaptured gain, which sit below the other gain, so in all four cases the $144,000 is taxed at 15% or 20%. Third, the NIIT is a layer of its own: it is 3.8% of the lesser of net investment income or the MAGI above $250,000 (26 U.S.C. 1411(a)(1), (b)(1)), and for a landlord whose rental is a passive activity the gain counts (26 U.S.C. 1411(c)(1)(A)(iii), (c)(2)(A)); Publication 527 says net investment income “may include rental income and other income from passive activities”.

Equipment, cost segregation and section 1245

Everything above assumes the building was depreciated as 27.5-year or 39-year property. A cost segregation study moves parts of the purchase price into 5-, 7- and 15-year classes, which are depreciated faster, and for qualified property acquired after January 19, 2025 the special allowance is 100% (IRS Topic no. 704; 26 U.S.C. 168(k)(1)(A)). Personal property in those classes is section 1245 property (26 U.S.C. 1245(a)(3)(A)), and the sale rule is harsher: the amount by which the lower of recomputed basis or amount realized exceeds adjusted basis is “treated as ordinary income” (26 U.S.C. 1245(a)(1)). Recomputed basis adds back depreciation “allowed or allowable”. A hypothetical, our arithmetic: $50,000 of carpet and appliances fully depreciated in a prior year (adjusted basis $0) and worth $20,000 at sale produce $20,000 of ordinary income, taxed at your bracket up to 37%, not at 25% or 15%.

The trade-off is a timing one. A study front-loads deductions and moves a larger part of the eventual gain from the 25% layer to ordinary rates. Our guide to the study, cost segregation, covers the IRS audit guide and the 2025 law; for how the whole gain stacks, see capital gains tax on real estate in 2026.

How it is reported: Form 4797, Schedule D line 19 and a worksheet

Rental real estate is depreciable property used in a trade or business or held for income, and its sale runs through Form 4797. Part III handles the recapture: for each property you enter the gross sales price (line 20), cost plus expense of sale (line 21), “Depreciation (or depletion) allowed or allowable” (line 22), adjusted basis (line 23) and total gain (line 24), then the recapture lines for section 1245 or section 1250 property. The Form 4797 instructions add that for a building and land sold together you must allocate the amount realized by fair market value, reporting the building in Part III and the land in Part I.

The 25% layer is tracked on Schedule D, line 19. The Instructions for Schedule D have an Unrecaptured Section 1250 Gain Worksheet whose first line, for a section 1250 property in Part III of Form 4797 that also has an entry in Part I, takes the “smaller of line 22 or line 24”, that is, the lesser of depreciation or gain, less any section 1250 ordinary recapture. The Schedule D Tax Worksheet then multiplies the part taxed at 25% (its line 39) by 25% (line 40). If you own through a partnership, the worksheet also asks for amounts reported to you on Schedule K-1 as “unrecaptured section 1250 gain” (line 5) and for amounts on Form 1099-DIV or Form 2439 from a REIT or a mutual fund (line 11). For how K-1 depreciation reaches a crowdfunding investor in the first place, see our guide to real estate crowdfunding taxes. The NIIT is figured on Form 8960.

Three ways it waits, shrinks or goes away

On the example property a successful 1031 exchange would defer the whole $266,174, including the $122,174 of unrecaptured gain, and a step-up at death would reset the $297,826 adjusted basis to the market value, so the heirs would owe nothing on the $144,000 of appreciation or the depreciation (our arithmetic and reading of the sections). Neither is a reason to hold or exchange on its own: the exchange has hard deadlines, covered in our guides to the 1031 exchange rules and the year-end 1031 timeline, and holding until death has a cost of its own.

What a reader can do with this

• Add up the depreciation you were allowed or could have claimed. Your prior returns show it on Form 4562 and Schedule E; if you never claimed any, the number is still the table amount, and a preparer can tell you whether to file Form 3115 before you sell.
• Split your purchase between land and building and keep the improvement list. Each improvement is a separate asset with its own depreciation and its own unrecaptured gain.
• Run your own numbers with the structure above: amount realized, minus cost and depreciation, gives the gain; the lesser of gain or depreciation is the 25%-capped layer; the rest is 0%, 15% or 20%; add the 3.8% if your MAGI is over the threshold.
• If any of the property was cost-segregated, add its section 1245 gain separately. That part is ordinary income.
• Before you sign a sale contract, ask whether a 1031 exchange, an installment sale or a later sale in a lower-income year fits, and check dates. This page does not model them.

FAQ

Sources, read and saved on October 7, 2026: 26 U.S.C. 1, 121, 168, 1014, 1016, 1031, 1231, 1245, 1250 and 1411 as published by the Legal Information Institute at Cornell; Revenue Procedure 2025-32 (2026 inflation adjustments); IRS Publication 946 (2025), How to Depreciate Property, including Tables A-6 and A-7a; IRS Publication 527 (2025); Instructions for Form 4797 (2025) and the Form 4797 (2025); Instructions for Schedule D (Form 1040) (2025), with the Unrecaptured Section 1250 Gain Worksheet and the Schedule D Tax Worksheet; and IRS Topic no. 704, last reviewed September 24, 2026. The IRS has not yet published the 2026 forms and worksheets; we used the 2025 versions and the 2026 amounts from Rev. Proc. 2025-32. The property, the dates, the prices and the income levels are hypothetical, and every sum, split, percentage and tax figure in the example is our arithmetic. This is analysis of public documents and the law, not tax, legal or investment advice.