The Short Version: Depreciation is one of real estate’s biggest tax advantages but the IRS wants that money back when you sell. It’s called depreciation recapture, and it catches a lot of investors off guard. The depreciation recapture portion is taxed at your ordinary income rate, not the lower capital gains rate. For high earners, that can mean 32-37%. If you don’t take depreciation while you own the property, you still owe recapture when you sell. Worst of both worlds. There are ways to defer or avoid the hit entirely 1031 exchanges, strategic reinvesting, or holding until death for a stepped-up basis. One of the biggest surprises for new real estate investors isn’t a bad tenant or a busted HVAC system. It’s the tax bill when they sell. They buy a property, hold it for a few years, sell it for a nice profit, and then get blindsided by something called depreciation recapture. Suddenly, that $100,000 gain they were celebrating turns into a much smaller check after Uncle Sam takes his cut. This happens all the time. And it’s almost always avoidable if you understand how real estate taxes actually work before you start investing. The Tax Break Nobody Explains Properly When you own investment real estate, the IRS lets you deduct depreciation every year. It’s one of the biggest tax advantages of real estate investing. You’re essentially writing off a portion of the property’s value each year, even though the property might actually be appreciating. On paper, this is fantastic. Depreciation can offset your rental income, reducing your tax liability while you hold the property. For many investors, it’s the difference between real estate being a good investment and a great one. But here’s what most people don’t realize until it’s too late and it’s the fact that the IRS wants that money back when you sell. What Is Depreciation Recapture? Depreciation recapture is exactly what it sounds like. The government gave you a tax break while you owned the property. When you sell, they recapture that benefit by taxing you on the depreciation you took. Let me run through a simple example to make this concrete. Say you bought a rental property for $100,000. Over five years, you depreciated $50,000 of that value on your tax returns. Now your “basis” in the property (your cost minus the depreciation) is $50,000. Then you sell the property for $200,000. Most people look at this and think: “I bought for $100,000, sold for $200,000, so I have $100,000 in capital gains. At a 15% capital gains rate, that’s $15,000 in taxes.” But that’s not how it works. Because your basis dropped to $50,000 (thanks to depreciation), the IRS sees $150,000 in total gain. And here’s the painful part: the $50,000 of depreciation recapture isn’t taxed at the capital gains rate. It’s taxed at your ordinary income rate which for high earners can be 32%, 35%, or even 37%. So instead of $15,000

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