How depreciation reduces your tax basis
Under IRS Publication 527, the residential building (not the land) is depreciated over 27.5 years using straight-line MACRS. Each full year, about 3.636% of the building value is deducted on Schedule E.
Every dollar of depreciation reduces your adjusted basis. If you bought a property for $300,000 ($60,000 land, $240,000 building) and took $87,273 of depreciation over 10 years, your adjusted basis falls to $212,727.
The 'allowed or allowable' trap
Basis is reduced by depreciation allowed or allowable (IRS Publication 551). In the sale rules, the greater of the two is generally the amount used (IRS Publication 544). Skipping the deduction does not avoid the tax: you can lose the deduction and still have your basis reduced. Our Schedule E guide covers the yearly side of depreciation, and the tax calculator shows what it saves you each year.
Unrecaptured section 1250 gain vs capital gains
Residential rental property placed in service after 1986 and depreciated straight-line normally has no "additional depreciation", so classic section 1250 recapture at ordinary rates does not usually apply (IRS Publication 544). What applies instead is the rate cap on unrecaptured section 1250 gain. When you sell a rental held for more than one year, the gain generally splits into two buckets:
- Unrecaptured section 1250 gain: the part of the long-term gain that is due to depreciation, taxed at no more than 25% (IRS Topic 409). It cannot exceed your actual gain.
- Long-term capital gain: the rest, taxed at 0%, 15%, 20% depending on your taxable income (Rev. Proc. 2025-32).
- Net investment income tax: the 3.8% tax under IRC §1411 can apply on top where modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly).
This split covers the building. Items depreciated separately, such as appliances or carpet, are generally not section 1250 property. Gain on them can be ordinary income up to the depreciation taken (IRS Publication 544), with no 25% cap, so the sale price may need allocating between them and the building.
Worked example of a sale
An investor bought for $350,000 ($70,000 land, $280,000 building), took $101,818 of depreciation over 10 full years (ignoring the mid-month convention), and sells for $500,000 with $30,000 of selling costs:
- Net sale proceeds: $500,000 − $30,000 = $470,000.
- Adjusted basis: $350,000 − $101,818 = $248,182.
- Total gain: $470,000 − $248,182 = $221,818.
- Unrecaptured section 1250 gain: $101,818 at up to 25% = up to $25,455.
- Remaining long-term gain: $120,000 at 15% or 20% = $18,000 to $24,000.
Deferring the tax: the section 1031 exchange
A like-kind exchange under section 1031 can defer the gain, including the depreciation part, by rolling it into replacement real property held for investment or business use. In a deferred exchange the deadlines are strict and run from the day you transfer the old property (IRS Publication 544):
- 45 days to identify the replacement property in a signed written document.
- 180 days to receive it, or by the due date of your tax return for that year (including extensions) if that comes first.
- Taking cash or other non-like-kind property can make part of the gain taxable, and receiving the sale proceeds yourself can turn the exchange into a sale. Exchanges are normally run through a qualified intermediary for this reason.
Questions landlords ask
What is the maximum tax rate on unrecaptured section 1250 gain?
The maximum federal rate is 25%, before any state income tax and the 3.8% net investment income tax where it applies.
What happens if I never claimed depreciation on my rental?
Your basis is still reduced by the depreciation that was allowable, so you can owe tax on a deduction you never took. Publication 527 covers claiming the correct amount of depreciation; ask a tax professional about correcting past years.
Can I avoid the tax with a 1031 exchange?
It defers the tax rather than removing it, and only if you meet the rules, including the 45-day and 180-day deadlines.
Does state income tax apply on the sale?
Usually, if your state has an income tax, but each state has its own rules. Check yours.
Tax rules: US registry v1.1.0, last reviewed 2026-09-30. Sources and method.