The depreciation bill that surprises long-held rental sellers

Jun 2026 · 4 min read

You sell a rental you've held for fifteen years. Bought at $550,000, selling for $850,000. You do the mental math: $300,000 of appreciation, long-term capital gains rates, maybe 20% in a high bracket. You budget around $60,000 of federal tax.

The actual federal bill is closer to $158,000.

That gap isn't a math error. It's a layer of tax most investors don't know exists until the return is in front of them, and on a long-held rental it's often the biggest layer. It's called unrecaptured §1250 gain, and it quietly reshapes the economics of selling property you've owned a long time.

What unrecaptured §1250 gain is, and how it works

The IRS lets you deduct part of a residential rental building's cost every year, over 27.5 years, straight-line. On a $550,000 building that's about $20,000 a year. Over fifteen years you've deducted roughly $300,000 against your rental income, real money you didn't pay tax on along the way. (This assumes the full $550,000 is building. In a real deal you carve out the land, which isn't depreciable, so both the depreciation and the §1250 layer come out smaller.)

Here's the catch: every dollar of depreciation lowers your basis, the number the IRS measures your gain against. After $300,000 of depreciation, your $550,000 property has an adjusted basis of $250,000. Sell for $850,000 and your gain is $600,000, not the $300,000 of appreciation you were picturing.

The code then splits that $600,000 in two, taxed differently. The part created by depreciation is unrecaptured §1250 gain, taxed at a maximum 25% rate. The rest, the appreciation above your depreciation, is long-term capital gain at 0%, 15%, or 20%. On top of either layer, higher-income sellers owe an extra 3.8% net investment income tax, because rental gain counts as investment income.

That depreciation layer caps out at 25%, higher than the 15% or 20% on the appreciation. The lever is the year you sell. In a lower-income year, the appreciation layer drops into lower brackets and you may slip under the NIIT line. Hold that thought.

Why it usually isn't taxed as ordinary income

"Depreciation recapture" sounds like the IRS clawing deductions back as ordinary income. For residential rentals placed in service after 1986, that mostly doesn't happen. Ordinary §1250 recapture applies only to depreciation taken above straight-line, and post-1986 residential rental is required to use straight-line. So there's no extra depreciation to recapture as ordinary income, the depreciation portion just gets capped at 25%.

Notice the proportions: depreciation ($300k) equals appreciation ($300k) here. On a property held twenty-plus years with modest appreciation, the §1250 layer can be larger than the capital-gain layer. The tax you thought was a footnote becomes the headline.

Where it goes wrong

• Budgeting for "20% of the appreciation" and ignoring the depreciation layer entirely.
• Assuming an installment sale lowers the rate. It doesn't prorate them. The unrecaptured §1250 portion is taken into account first and taxed at 25% before the remaining capital-gain rates apply (spreading still helps with brackets and NIIT).
• Forgetting the NIIT. Its $200k single / $250k joint thresholds aren't adjusted for inflation, so more sellers cross them every year.

What to model before you list

• Pull your depreciation schedule. How much have you actually deducted? That's your §1250 layer.
• Separate the two layers before you sign anything, the depreciation piece (up to 25%) and the appreciation piece.
• Could you sell in a lower-income year (a gap between roles, an early-retirement year)? The cap can fall, and you may slip under the NIIT line.
• Is a §1031 exchange, or holding for the step-up at death, on the table? Both sidestep the recapture entirely.

If you've got a rental sale on the horizon, the Gnomon Diagnostic lays your depreciation schedule, projected gain, and sale-year income side by side so the 25% layer isn't a surprise. Start yours at start.gnomonplan.com.

This is general tax information, not advice for your specific situation. Talk with us or your tax professional before acting on it.