Depreciation Recapture Still an Issue When You Break Even ~ Part 1

We need­ed to advise a poten­tial client that they may need to pay a 25% recap­ture of the depre­ci­a­tion tak­en on their invest­ment prop­er­ty even though they broke even on the sale.  What may make mat­ters worse is that the depre­ci­a­tion recap­ture may also be due if sell­ing at a loss. Yes — depre­ci­a­tion recap­ture is still required even if you sell an invest­ment prop­er­ty at break-even or at a loss, but only up to the amount of gain attrib­ut­able to depre­ci­a­tion.

Decem­ber 14, 2025

By Al DiNi­co­la, AIF®
1031 Tax Deferred Exchange Spe­cial­ists & DST Advi­sor
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

This may be a very con­fus­ing reg­u­la­tion that is in place and poten­tial­ly hard to fol­low. Recent­ly the investor con­tact­ed us inquir­ing about enter­ing into a §1031 exchange but cal­cu­lat­ed they would be break­ing even or sell­ing at a slight loss. At their point in life, they want­ed to elim­i­nate the active man­age­ment of the real estate prop­er­ty.  There was a slight inter­est in acquir­ing a Delaware Statu­to­ry Trust (DST) because of the advan­tages of pas­sive own­er­ship. How­ev­er, they sim­ply want­ed to move on and not get involved in a §1031 exchange, up until they real­ized the con­se­quences. Our first ques­tion to a poten­tial investor client is “did your CPA/Accountant cal­cu­late cap­i­tal gains and tax­es that may be due.  There is the issue. There was no CPA involved. We are not oper­at­ing as a CPA and do not offer tax advice.  The infor­ma­tion con­tained is for edu­ca­tion­al pur­pos­es and to assist investors. Investors should have a clear under­stand­ing of the rules regard­ing recap­ture of depre­ci­a­tion.

Depre­ci­a­tion recap­ture applies to the extent that the property’s sale price (minus sell­ing costs) exceeds its adjust­ed basis — NOT its orig­i­nal pur­chase price. So, what exact­ly does that mean. If you claimed depre­ci­a­tion, your adjust­ed basis decreas­es. The IRS cal­cu­lates depre­ci­a­tion on invest­ment real estate even if you did not claim the deduc­tion on your tax­es. This is because depre­ci­a­tion is a tax strat­e­gy to allo­cate the invest­ment cost of the prop­er­ty over a spec­i­fied peri­od, which is not reflect­ed in the prop­er­ty’s mar­ket val­ue. The depre­ci­a­tion deduc­tion reduces your tax­able rental income, allow­ing you to recov­er the cost of the prop­er­ty over its use­ful life. This deduc­tion is not a cash expense but rather a non-cash expense that can be deduct­ed each year you hold the prop­er­ty for income-gen­er­at­ing use.

Here is the unfor­tu­nate sit­u­a­tion. If your sales price exceeds that low­er adjust­ed basis, you may owe depre­ci­a­tion recap­ture even if the sale seems like a break-even or a loss com­pared to orig­i­nal cost.

Why This Hap­pens

Depre­ci­a­tion recap­ture is based on the idea that “You must pay tax on the depre­ci­a­tion ben­e­fit you used if the prop­er­ty recov­ered that val­ue at sale.”  So, the IRS ignores your orig­i­nal pur­chase price, whether you prof­it­ed over­all, whether cash flow was neg­a­tive, or whether you net­ted a loss rel­a­tive to your eco­nom­ic invest­ment. Instead, it looks ONLY at the adjust­ed basis and the amount real­ized on sale.

Let’s take a look at a few exam­ples. We hope to pro­vide poten­tial­ly clear and sim­ple exam­ples. Here is a prop­er­ty overview. Res­i­den­tial apart­ments acquired for $1,000,000 and fall under the res­i­den­tial depre­ci­a­tion sched­ule of 27.5 years. Land allo­ca­tion at 15% of val­u­a­tion for cal­cu­la­tion pur­pos­es. The investor held the prop­er­ty for 10 years and has seen prop­er­ty val­ues go up and now set­tle back down.

Exam­ple 1: Investors believe they sold at “Break Even” vs. Orig­i­nal Cost

Out­come:

Investor owes depre­ci­a­tion recap­ture — despite break­ing even.

Exam­ple 2: Investor sold at a “Loss” vs. Orig­i­nal Cost, Investor Still Owes Recap­ture using same exam­ple above.

Out­come:

Still owe recap­ture even though prop­er­ty sold below orig­i­nal cost.

Exam­ple 3: Sold Below Adjust­ed Basis → No Recap­ture at All

This is the ONLY sit­u­a­tion where recap­ture does NOT apply.

Out­come:

• Sale price below adjust­ed basis
• No gain, there­fore, no recap­ture
• May report a cap­i­tal loss

Bot­tom Line

• Investor owes depre­ci­a­tion recap­ture ONLY if your sale price exceeds your adjust­ed basis.
• Investor may owe it even when the sale is a “break-even” or a “loss” in every­day terms.
• No recap­ture is due if the prop­er­ty sells below adjust­ed basis.
• Investor may defer any depre­ci­a­tion recap­ture by exe­cut­ing a §1031 exchange

In Part 2 we will review sell­ing prop­er­ty at break even or at a loss when the loan is being paid off and the advan­tages of a poten­tial 1031 tax deferred exchange. In addi­tion, how a DST may be a poten­tial solu­tion.

As always con­tact us for more infor­ma­tion and a com­pli­men­ta­ry con­sul­ta­tion.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

Alter­na­tive invest­ments and DSTs are not for all investors.  The acqui­si­tion of a cer­tain alter­na­tive invest­ments includ­ing DSTs is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your §1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC §1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.