How to Model Depreciation Recapture on a Client’s Rental
Depreciation recapture is usually the largest tax line an advisor has never quantified for a client. It is also the one clients are most surprised by, because the deduction that helped them for years turns into a bill in the year they sell. This page covers how it works, what it stacks with, and how Leveridge calculates it for each property a client already owns.
What depreciation recapture is
Every year a client owns a rental, they deduct depreciation. That deduction reduces the property’s adjusted basis. A lower basis means a larger gain when the property sells, so the benefit taken during ownership is settled at exit.
On the sale, the portion of the gain attributable to depreciation is treated as unrecaptured Section 1250 gain. It is taxed separately from long-term capital gain, at a different rate, on the same transaction.
One rule catches people. Recapture applies to depreciation allowed or allowable. A client who never claimed the deduction is still taxed as though they had. Skipping depreciation does not avoid recapture, it only forfeits the deduction.
Why 25% is a ceiling, not a rate
The 25% figure is the most misquoted number in a rental sale. It is a maximum, not a flat rate.
Unrecaptured Section 1250 gain stacks on top of the client’s ordinary income and is taxed at whatever bracket it lands in, capped at 25%. A client whose income keeps them below that cap pays less. Applying a flat 25% to every client overstates the tax for some of them, and it is the single most common error in a back-of-the-envelope estimate.
Leveridge computes the bracket placement rather than applying the ceiling as a flat rate, which is why its recapture figure often differs from a calculator that multiplies accumulated depreciation by 0.25.
How the depreciation figure is calculated
Residential rental property depreciates straight-line over 27.5 years. The schedule starts on the date the property was placed in service, not the date it was purchased, and uses a half-month convention in the first and last years.
Land does not depreciate. Only the improvement portion of the purchase price is depreciated, so the split between land and improvements changes the answer materially.
Leveridge derives that split from assessed values, bounded between 60% and 80% improvements, and defaults to 70% when assessment detail is not available. The bounds exist because assessment ratios at the extremes usually reflect a data artifact rather than a real land value, and an unbounded ratio produces a depreciation figure that is confidently wrong. This is a default assumption, not a fixed rule. The split is visible on the property and the advisor can override it when they have better information, such as an appraisal or a cost segregation study.
Accumulated depreciation is then the total claimed from the date placed in service through the end of the year before the sale year.
What it stacks with on exit
Recapture is one component of exit tax, not the whole of it. Three others land on the same sale.
Long-term capital gain
The gain above the depreciation portion, taxed at the client's long-term capital gains rate. This is a separate calculation from recapture, and the two are taxed at different rates on the same sale.
State income tax
Most states tax the full gain as ordinary income and do not mirror the federal treatment of unrecaptured Section 1250 gain. For a client in a high-tax state this can be the largest single line after the federal gain.
Net Investment Income Tax
An additional 3.8% applies to net investment income above the applicable threshold. A property sale often pushes a client over that threshold in the year of sale even when their normal income sits below it.
Leveridge calculates all four together and presents them as a single exit tax figure with the components broken out, so the advisor can see which line is driving the total rather than only the sum.
How Leveridge models it
Leveridge reads the client’s tax return and builds each property from Schedule E, so the depreciation already claimed comes from the return rather than from an estimate. With the date placed in service, it computes accumulated depreciation per property and carries that into the exit tax calculation.
Open a property to see the exit tax breakdown alongside cash flow, equity, and appreciation. The calculation is deterministic, and a traceability view on each figure shows where the value came from, so the recapture number can be checked line by line rather than taken on faith.
Recapture also appears in the strategy comparison, which is where it usually changes the conversation. Selling triggers it. Holding defers it and keeps accruing more. A 1031 exchange defers it into the replacement property. Seeing the three side by side is what turns recapture from a surprise into a planning input.
A worked example
A client bought a rental for $400,000 in 2011 and placed it in service that year. After separating out the land, the depreciable basis is $280,000, which depreciates at roughly $10,180 a year over 27.5 years. By the end of 2025 they have claimed close to $145,000.
If the property is now worth $850,000, that $145,000 of accumulated depreciation is the portion of gain subject to recapture, taxed at their bracket up to the 25% ceiling. The remaining gain is long-term capital gain, and state tax and the 3.8% NIIT apply on top.
The number worth showing the client is not the sale price. It is what they actually keep after all four lines, which is frequently well below what they assumed.
What gets missed
Applying 25% as a flat rate
It is a ceiling. The recapture amount stacks on ordinary income and is taxed at the bracket it lands in.
Starting the schedule at the purchase date
Depreciation runs from the date the property was placed in service. For a property bought and renovated before being rented, those are different dates.
Depreciating the full purchase price
Land is not depreciable. Using the full price instead of the improvement portion overstates both the deduction and the eventual recapture.
Assuming a 1031 exchange erases it
An exchange defers recapture into the replacement property through a reduced basis. The liability travels with the client rather than disappearing.
Treating it as a sale-year problem
The liability accrues every year the client holds. An advisor who quantifies it before the client is ready to sell is doing planning; one who quantifies it during escrow is reporting.
This page explains how Leveridge calculates depreciation recapture and is intended for financial advisors. It is not tax advice. Filing positions, elections, and the treatment of a specific client’s facts belong with the client’s CPA or tax attorney.
Related guides
Where recapture stops being a tax figure and starts being a decision input.
The path that defers recapture rather than triggering it, and what that costs.
How the platform works end to end, from setting up a client to generating reports.