Depreciation Recapture Still an Issue Even When You Break Even ~ Part 2.

In Part 1 we revealed that 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. The fol­low up may be what if you had a loan on the prop­er­ty that was paid off and how that may affect you. 

Decem­ber 20, 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

In addi­tion, can a §1031 exchange pro­vide any relief. Click here to see Part 1. Depre­ci­a­tion Recap­ture Still an Issue When You Break Even ~ Part 1 — DST Edu­ca­tion and Mar­ket News

A com­mon mis­con­cep­tion is: “If I sell at break-even or a loss, I shouldn’t owe depre­ci­a­tion recap­ture.” As we reviewed in Part 1 the recap­ture is based on depre­ci­a­tion tak­en (or allowed), NOT on gain vs. loss. Unfor­tu­nate­ly.

There is a Depre­ci­a­tion recap­ture for­mu­la: Recap­ture = the less­er of (A) depre­ci­a­tion tak­en and (B) total gain. How­ev­er, as with many invest­ments there is a catch. When you pay off a loan, your “gain” for tax pur­pos­es may be dif­fer­ent from what peo­ple call “break-even.” Tax law cal­cu­lates gain using adjust­ed basis, not whether you walked away with cash. Yes, this can be con­fus­ing.  We are not offer­ing tax advice, and this arti­cle is intend­ed to raise ques­tions and aware­ness of poten­tial options.

Why you may still have “Gain” when you think you’re break­ing even. In most cas­es investors cal­cu­late break-even with a sim­ple cal­cu­la­tion (phi­los­o­phy). The sale price minus loan pay­off equal zero ($0). The investor thinks “I broke even.” But the IRS cal­cu­lates tax­able gain like this. The Sale Price minus the total clos­ing costs and cost of sale minus the adjust­ed basis to arrive at the tax­able gain.

Your adjust­ed basis goes down every year because of depre­ci­a­tion. Res­i­den­tial depre­ci­a­tion is over 27.5 years, and all oth­er com­mer­cial prop­er­ties depre­ci­a­tion sched­ule is over 39 years. There may be investors with ful­ly depre­ci­at­ed prop­er­ties in cer­tain loca­tions in the USA fac­ing mar­gin­al appre­ci­a­tion even after being held for an extend­ed peri­od of time. So even if you receive no cash, the IRS may still show you sold for more than your adjust­ed basis. These types of cal­cu­la­tion will cre­ate gain. Gain is recap­tured as §1250 depre­ci­a­tion recap­ture. We are not offer­ing tax advice, and the fol­low­ing is once again for illus­tra­tion pur­pos­es.

Here is an exam­ple of a prop­er­ty being sold.

IRS cal­cu­la­tion:

4. When You Sell at a True Loss (Below Adjust­ed Basis)

If you sell below your adjust­ed basis, there is no depre­ci­a­tion recap­ture, because recap­ture requires a gain.

Result: There is No depre­ci­a­tion recap­ture. There may be a deductible cap­i­tal loss (if invest­ment prop­er­ty). Even if you had a loan pay­off of $350,000, tax­able gain is based on adjust­ed basis, not cash flow.

Why Pay­ing Off the Loan Con­fus­es Things

The IRS doesn’t care how much loan you pay off. The loan pay­off only affects cash, not tax­able gain. In more expen­sive invest­ment prop­er­ties, you may pay off a $1M loan, receive $0 cash and still owe tax­es. The rea­son is because tax­es depend on adjust­ed basis vs. sale price, not cash.

This sit­u­a­tion is com­mon with old­er prop­er­ties that have accu­mu­lat­ed depre­ci­a­tion.

Investors who sell above the adjust­ed basis (even if they walk away with no cash) may or will have a tax­able gain accord­ing to the IRS. If you sell below the adjust­ed basis (which may require bring­ing cash to clos­ing) the IRS will not con­sid­er that a tax­able gain. Regard­less of the type of loan (recourse or no recourse) that does not affect the basis.

The big chal­lenge and ques­tion may be what you do to avoid recap­ture. It would appear that you have only a few legal options. Investors would be wise to seek their own CPA advice. Here may be a few options.

A. Do a 1031 tax deferred exchange which com­plete­ly defers depre­ci­a­tion recap­ture. We have authored many arti­cles on the mer­its (and draw­backs) of a §1031 exchange. This becomes dif­fi­cult with lim­it­ed cash out from the sale. We will illus­trate a poten­tial option for some accred­it­ed investors.

B. Sell at a loss on the adjust­ed basis on which there would be no recap­ture but often require bring­ing cash to clos­ing.

C. Con­vert to pri­ma­ry res­i­dence (com­pli­cat­ed and lim­it­ed) and some depre­ci­a­tion recap­ture still unavoid­able.

Quick review on a §1031 exchange defers depre­ci­a­tion recap­ture because the IRS treats your sale and pur­chase as one con­tin­u­ous, unin­ter­rupt­ed investment—not as a tax­able sale fol­lowed by a new pur­chase.

Here’s are the 1031 bul­let points:

1. The IRS says you didn’t “sell” any­thing

2. Your old basis moves into the New Prop­er­ty (Car­ry­over Basis)

3. The depre­ci­a­tion clock resets (with some lim­i­ta­tions) … but the tax defer­ral stays

4. The deferred recap­ture fol­lows you into the New Prop­er­ty

5. The “Swap Until You Drop” estate Strat­e­gy

Accred­it­ed investors may have an option, but suit­abil­i­ty is always a con­cern.  If the investor needs to write a check to the IRS for the recap­ture of depre­ci­a­tion are there any oth­er options? One poten­tial option may be to acquire an inter­est in a Delaware Statu­to­ry Trust (DST) that is high­ly lever­aged. DSTs with high lever­age are designed to max­i­mize poten­tial tax strate­gies. High­ly lever­aged DSTs may be ref­er­enced as “Zero” DST.  Typ­i­cal­ly, the high­ly lever­aged DST will not pay a dis­tri­b­u­tion but will direct all pay­ments to retir­ing the non-recourse debt on the prop­er­ty. We have seen this in sev­er­al dis­tri­b­u­tion cen­ters (Ama­zon). Each investor sit­u­a­tion is dif­fer­ent and bal­anc­ing the §1031 exchange is crit­i­cal­ly impor­tant.  Three finan­cial com­po­nents need to be in place: replace the val­ue, replace the debt and use all the cash. There is no easy solu­tion when sell­ing at break even. How­ev­er, dis­cov­er­ing poten­tial strate­gies may be ben­e­fi­cial.

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 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 com­pa­ny mail­ing address is 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.