What is depreciation recapture?

I feel like this is a topic that is not talked about enough.

Many of you are familiar with the benefits of rental real estate.

You can buy (or invest in) a property, rent it, have positive cash flow ($$$ for you), and still not pay tax on it – since you get to take depreciation expense each year.

Sounds cool, and it is.

But what happens when you sell this property?

If you bought it for $800,000 and you sell it for $1,000,000, your gain is $200,000, right?

Wrong.

The IRS says you cannot claim depreciation each year (reducing your income tax each year) and then sell it for a profit without “repaying” the IRS.

Without getting too technical, in effect, when you sell, you will need to recognize all of the depreciation (that you expensed over the years) as additional profit on the sale.

Yes, there are potential ways to defer this recognized gain (such as a 1031 exchange), but everyone who invests in rental real estate needs to be aware of the depreciation recapture concept.