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When you sell a residential rental for more than its adjusted basis, the depreciation you took is part of the taxable gain. Federal tax law caps the rate on that slice, called unrecaptured section 1250 gain, at 25 percent. A qualifying like-kind exchange can defer the gain. It does not erase the depreciation that already lowered your basis.
By RentalAnalytics Editorial Team · Published October 19, 2026
You depreciate the building, not the land. Publication 527 says land generally does not wear out, so its cost is not depreciated. The residential rental class is a building or structure for which 80 percent or more of the gross rental income is from dwelling units. A hotel or motel where more than half the units are transient does not qualify.
Under the general depreciation system, the recovery table lists 27.5 years for those buildings and structural components. You must use straight line and a mid-month convention. Property placed in service or sold during a month is treated as placed in service or sold at mid-month, so the first year and the year of sale are partial.
A full year of straight line on a $275,000 building is $275,000 divided by 27.5, or $10,000. That is a checkpoint, not year one. Publication 527's own example is a house bought for $185,000, with $160,000 allocated to the building and $25,000 to the land, placed in service on February 8. Table 2-2d's February year-one rate is 3.182 percent, and the publication states the deduction as $5,091.
Publication 527 says you decrease basis by depreciation you deducted or could have deducted. If you did not claim all the depreciation you were entitled to, you still reduce basis by the full amount you could have deducted. Skipping the deduction does not keep that amount out of the gain.
For property held more than one year, the Schedule D instructions start unrecaptured section 1250 gain with the smaller of depreciation allowed or allowable, or the total gain. They then subtract any ordinary section 1250 recapture.
Topic 409 taxes unrecaptured section 1250 gain at a maximum 25 percent rate. Publication 544 calls it the part of long-term gain on real property that comes from depreciation. It cannot exceed net section 1231 gain, and it excludes gain already treated as ordinary income. The 2025 Schedule D instructions run it through the Unrecaptured Section 1250 Gain Worksheet, and the tax worksheet multiplies the remaining portion by 25 percent.
Ordinary section 1250 income is additional depreciation, meaning depreciation above straight line after a holding period of more than one year. Publication 544 says you will not have additional depreciation on residential rental property placed in service after 1986 if you held it more than one year and, where it was qualified property, you elected out of any special depreciation allowance. Those buildings use straight line, so the depreciation is unrecaptured section 1250 gain.
Any remaining long-term gain is taxed at 0, 15, or 20 percent, depending on taxable income, for tax years beginning in 2025. Topic 409 points readers with significant investment income to Topic 559 for the net investment income tax.
The sale figures below are round examples.
The smaller of $100,000 of depreciation and $250,000 of gain is $100,000. Ordinary recapture is $0 on the straight-line facts above, so unrecaptured section 1250 gain is $100,000. Tax at the 25 percent maximum is $25,000. The tax is lower if ordinary rates on that slice are lower.
The other $150,000 follows the 0, 15, or 20 percent long-term rates. At 15 percent that slice is $22,500. At 20 percent it is $30,000. At 0 percent it is $0. Buyers set a price from income in how to value a rental property from its rental income. The tax math uses basis after depreciation.
Form 8824 figures the gain deferred when you exchange business or investment real property solely for like-kind real property. Since 2018 that treatment is limited to real property. Cash or other non-like-kind property forces recognition of gain now. The form also sets your basis in the property received.
Line 15, the boot, is cash you receive, plus non-like-kind property, plus net debt relief, minus exchange expenses, not below zero. Recognized gain is generally the smaller of boot or realized gain. Line 24 is what you defer. Line 25 is the new basis, which stays lower because the deferred gain is not added back. Line 21 can still tax additional depreciation as ordinary income. On the straight-line facts above that amount is zero, so with no boot the $250,000 example gain is deferred until a later taxable sale.
Identify the replacement within 45 days, and receive it within 180 days or by the return due date including extensions, whichever is earlier. 1031 exchange basics for rental investors follows that clock. Personal use is covered in can a vacation rental qualify for a 1031. Boot is covered in partial 1031 exchange explained and partial 1031 exchanges and real costs. The 1031 exchange calculator reports boot, deferred gain, and both dates from the Form 8824 lines.
Publication 527 uses 27.5 years, straight line, and a mid-month convention for the building. Land is not depreciated. The first year and the sale year are partial.
It is the depreciation portion of long-term gain on real property, after any ordinary section 1250 recapture. Topic 409 caps the federal rate at 25 percent. Schedule D measures it from depreciation allowed or allowable, limited by total gain.
You still reduce basis by the amount you could have deducted. Schedule D uses depreciation allowed or allowable. Skipping the deduction does not keep the original basis.
It can defer the gain when the exchange qualifies and boot does not force recognition. Form 8824 parks that gain on line 24 and sets the new basis on line 25. Additional depreciation can still be ordinary income. Straight-line residential rentals placed in service after 1986 and held more than a year generally do not have additional depreciation.
No. Twenty-five percent is the maximum on unrecaptured section 1250 gain. The example's $100,000 slice is $25,000 only at that maximum. The other $150,000 is taxed at 0, 15, or 20 percent based on taxable income.
Pull the depreciation already on your schedule, subtract it from cost to get adjusted basis, and compare that with the price in the contract. Then enter the exchange figures in the 1031 exchange calculator if you are swapping rather than cashing out. Take the worksheet and the current Form 8824 instructions to your preparer before you close.
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