Capital Gains Taxes and Depreciation Recapture: What Real Estate Investors Need to Know

Over the past few months, we have post­ed arti­cles on the tax impli­ca­tions even if you break even or sell­ing an invest­ment prop­er­ty for a loss.  We con­tin­ue to have fol­low up ques­tions on the process and sequence of cap­i­tal gains and depre­ci­a­tion recap­ture.

Feb­ru­ary 6, 2026

By Al DiNi­co­la, AIF®
Adinicola@namcoa.com
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

We are not pro­vid­ing tax advice and this post attempts to estab­lish the sequence of how the invest­ment prop­er­ty may be taxed when sold (with­out a §1031 exchange). When sell­ing real estate held for invest­ment, some investors are sur­prised to learn that their prof­it is often taxed in two sep­a­rate ways. Under­stand­ing cap­i­tal gains tax­es and depre­ci­a­tion recap­ture is essen­tial for effec­tive tax plan­ning. This under­stand­ing is espe­cial­ly crit­i­cal if you are con­sid­er­ing a §1031 exchange or long-term real estate strat­e­gy.  When you sell invest­ment real estate, the IRS tax­es your gain in a spe­cif­ic order. Depre­ci­a­tion recap­ture is applied first, and cap­i­tal gains are cal­cu­lat­ed on what remains. This arti­cle breaks down both con­cepts in clear, plain lan­guage and explains why they mat­ter.

What Are Cap­i­tal Gains Tax­es?

Cap­i­tal gains tax­es apply to the increase in val­ue of a prop­er­ty from the time it was pur­chased to the time it is sold. Under­stand­ing the cal­cu­la­tion is impor­tant. Cap­i­tal gains are cal­cu­lat­ed using the fol­low­ing for­mu­la: Sale Price minus Adjust­ed Cost Basis equals Cap­i­tal Gain. Your adjust­ed cost basis gen­er­al­ly includes orig­i­nal pur­chase price, cer­tain clos­ing costs, cap­i­tal improve­ments, minus accu­mu­lat­ed depre­ci­a­tion and poten­tial oth­er mis­cel­la­neous items.

Cap­i­tal Gains Tax Rates

For real estate held longer than one year, gains are typ­i­cal­ly taxed at long-term cap­i­tal gains rates, which are gen­er­al­ly low­er than ordi­nary income tax rates. Rates vary based on income lev­el and may be com­bined with applic­a­ble state tax­es.

What Is Depre­ci­a­tion Recap­ture?

Depre­ci­a­tion recap­ture is a sep­a­rate tax that applies to the depre­ci­a­tion deduc­tions you claimed (or were allowed to claim) dur­ing the time you owned the prop­er­ty. Depre­ci­a­tion low­ers your property’s adjust­ed basis over time. While depre­ci­a­tion reduces tax­able income dur­ing own­er­ship, the Inter­nal Rev­enue Ser­vice requires investors to “recap­ture” that ben­e­fit when the prop­er­ty is sold.

Key Facts About Depre­ci­a­tion Recap­ture

• Applies to depre­ci­a­tion tak­en on invest­ment real estate. (IRS assumes depre­ci­a­tion was tak­en even if tax pay­er did not claim).
• Taxed at a max­i­mum fed­er­al rate of 25%.
• Owed even if the prop­er­ty does not sell at a prof­it.
• Depre­ci­a­tion comes off first.
• Cal­cu­lat­ed before cap­i­tal gains tax­es

Many investors under­es­ti­mate this tax because it is less vis­i­ble than cap­i­tal gains.

Cap­i­tal Gains vs. Depre­ci­a­tion Recap­ture: A Sim­ple Exam­ple

Let’s look at a sim­pli­fied sce­nario. Prop­er­ty was pur­chased at $500,000. Depre­ci­a­tion tak­en over time of own­er­ship of $150,000. The sale price: $900,000.

Step 1: Cal­cu­late the Depre­ci­a­tion Recap­ture FIRST.

• $150,000 (depre­ci­a­tion tak­en) × 25% (recap­ture rate) = $37,500

Step 2: Cap­i­tal Gains is then cal­cu­lat­ed.

• Adjust­ed basis: $500,000 (orig­i­nal pur­chase price) − $150,000 (depre­ci­a­tion tak­en) = $350,000 (now the adjust­ed basis).
• Cap­i­tal gain: $900,000 (sales price) − $350,000 (adjust­ed basis) = $550,000 (cap­i­tal gain amount to be taxed).
• Cap­i­tal Gain tax­es cal­cu­lat­ed at 20% (US cap­i­tal gains rate 0% to 20%) =$110,000.

Both tax­es apply unless they are deferred through a tax-plan­ning strat­e­gy.

Why These Tax­es Mat­ter for Real Estate Investors

When com­bined, depre­ci­a­tion recap­ture and cap­i­tal gains tax­es can sig­nif­i­cant­ly reduce net sale pro­ceeds. In many cas­es, total tax expo­sure can exceed 30–40% of the gain, par­tic­u­lar­ly when state tax­es are includ­ed. In the illus­tra­tion above recap­ture plus cap­i­tal gains tax­es equals $147,500 with any oth­er tax cal­cu­la­tion. (That is 26.8% of the gain).

Why This Mat­ters for Plan­ning

Under­stand­ing the order of tax­a­tion helps investors accu­rate­ly esti­mate net pro­ceeds and avoid under­es­ti­mat­ing tax lia­bil­i­ty. This is why proac­tive plan­ning is crit­i­cal for investors near­ing a sale. Investors may be sub­ject­ed to state tax­es as well. There is addi­tion­al tax NIIT (Net Invest­ment Income Tax) estab­lished after depre­ci­a­tion recap­ture is deter­mined, but it is cal­cu­lat­ed on the same rec­og­nized gain. Depend­ing on your mod­i­fied adjust­ed gross income (MAGI) you may or may not be sub­ject­ed to this tax.

Strate­gies Investors Often Con­sid­er

While every sit­u­a­tion is unique, investors com­mon­ly explore strate­gies such as:

• §1031 exchanges to defer both cap­i­tal gains and depre­ci­a­tion recap­ture
• Port­fo­lio diver­si­fi­ca­tion to reduce con­cen­tra­tion risk.
• Pas­sive own­er­ship struc­tures for retire­ment plan­ning
• Uti­liza­tion of Delaware Statu­to­ry Trust (DST) for replace­ment prop­er­ty in an exchange
• Estate plan­ning strate­gies that may reduce future tax bur­dens

Con­sult­ing with a qual­i­fied tax advi­sor or real estate pro­fes­sion­al is essen­tial before mak­ing deci­sions.

Final Thoughts

Cap­i­tal gains tax­es and depre­ci­a­tion recap­ture are two distinct—but close­ly related—taxes that apply when sell­ing invest­ment real estate. Under­stand­ing how each works allows investors to plan more effec­tive­ly, pre­serve wealth, and make informed rein­vest­ment deci­sions.

With the right strat­e­gy in place, these tax­es can often be man­aged, deferred, or strate­gi­cal­ly planned around rather than becom­ing an unex­pect­ed sur­prise.

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.

DSTs are not for all investors.  The acqui­si­tion of a DST 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, 97035.  MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.