Depreciation Recapture

Depreciation recapture is the tax, collected when a property is sold, on the depreciation deductions taken while it was owned. It is part of the after-tax cost of the tax shelter a rental provides, and it never appears in the pre-tax cash on cash return.

Straight-line depreciation on a $400,000 building value comes to about $14,545 a year. Over five years that is roughly $72,700 of deductions, and at sale that amount is generally taxed separately from the rest of the gain. For US residential property the federal rate on it is capped at 25%.

Recapture is why the tax benefit of depreciation is mostly a deferral. The deductions lower taxes during the hold, and part of that comes back at the sale. Investors who plan to hold until death or to exchange into another property treat the math differently, so the timing matters.

Further reading: Depreciation Recapture on Wikipedia.