When you sell an LA apartment building, the IRS taxes back a portion of the depreciation deductions you claimed during your ownership. This is depreciation recapture, and for owners with long holding periods it is often the larger tax component of the sale — sometimes larger than the capital gains tax on the actual appreciation. For most LA multifamily owners who have held the building 15 years or more, the depreciation recapture liability is the line item that produces the biggest gap between the gross sale price they see on the closing statement and the net cash they actually keep.
The recapture mechanism is well-established federal tax law (Section 1250 of the Internal Revenue Code, for real property), but it is among the least-understood components of multifamily sale economics. Most owners, asked what their tax bill will be on a sale, can roughly estimate the capital gains. Few can estimate the depreciation recapture, even though it is the larger number for most long-held buildings.
During the years you owned the building, you deducted a portion of the building's value as depreciation each year (residential rental real estate is depreciated over 27.5 years using straight-line method under current US tax law). These deductions reduced your taxable income each year and saved you taxes at your then-applicable income tax rate.
When you sell, the IRS recovers a portion of those deductions through depreciation recapture. The accumulated depreciation reduces your tax basis in the building. The difference between the sale price and your reduced basis is the gain. The portion of the gain attributable to the accumulated depreciation is taxed at the depreciation-recapture rate (currently capped at 25% federal for real property). The remainder of the gain — the actual appreciation above the original cost basis — is taxed at capital-gains rates.
A worked example. You bought a building 25 years ago for $1,000,000. You depreciated it $36,000 per year (roughly $1,000,000 ÷ 27.5) over 25 years, for total accumulated depreciation of $900,000. Your tax basis is now $100,000 (original cost minus accumulated depreciation, ignoring capital improvements for simplicity). You sell the building today for $4,000,000.
Your gain is $3,900,000 ($4,000,000 sale price minus $100,000 basis). Of that $3,900,000:
- $900,000 is depreciation recapture (the amount of accumulated depreciation)
- $3,000,000 is capital gain (the appreciation above the original $1,000,000 cost)
Federal tax on the recapture: $900,000 × 25% = $225,000.
Federal tax on the capital gain: $3,000,000 × 20% (long-term rate, assuming you qualify) = $600,000.
Plus 3.8% net investment income tax for higher earners on the full $3,900,000 = $148,200.
Federal total: approximately $973,200.
California state tax adds on top. California taxes capital gains at ordinary-income rates (up to 13.3%). California does not distinguish between depreciation recapture and capital gain — both are taxed at the same ordinary rate. State tax on the $3,900,000 gain at 13.3% = approximately $518,700.
Combined federal and state tax bill: approximately $1,491,900 on a $3,900,000 gain. The seller's net after-tax proceeds (before transaction costs) are roughly $2,408,100 from a $4,000,000 sale.
That number — net cash after tax — is what owners actually keep. It is often substantially less than the gross sale price they tell their family they sold the building for.
The example simplifies several real-world adjustments.
Capital improvements. Substantial capital improvements made during ownership add to the basis and are themselves depreciated. The basis calculation has to include the original cost plus any capitalized improvements minus accumulated depreciation on each component.
Sale of personal property. A portion of the sale price often allocates to personal property (appliances, fixtures classified as personal property under cost segregation). Personal property is depreciated under Section 1245 with a different recapture mechanic — ordinary-income recapture up to the amount of depreciation taken, capped at the gain. Sellers who took cost segregation deductions during ownership typically have meaningful Section 1245 recapture exposure separate from the Section 1250 (real property) recapture.
Closing costs. Selling costs (broker commission, title, escrow, transfer taxes, attorney fees) reduce the amount realized on the sale, which reduces the gain.
Tax basis adjustments from prior 1031 exchanges. If the current building was acquired through a 1031 exchange from a prior property, the basis carries over from the relinquished property, often making the current basis substantially lower than the cash invested. The accumulated depreciation also typically carries through prior exchanges.
Bonus depreciation and Section 168(k). Buildings that benefited from accelerated depreciation or bonus depreciation under various time-limited provisions (the cost segregation industry has been active in this for decades) have higher accumulated depreciation than straight-line would have produced, and therefore higher recapture on sale.
These adjustments are not optional considerations. They are necessary inputs to the actual tax calculation, and they require pulling the building's tax history from the seller's accountant — not estimating from generic assumptions.
A 1031 exchange defers both the capital gain and the depreciation recapture. The replacement property takes a carryover basis that preserves the deferred liability for eventual recognition. The deferral is not forgiveness — eventually, when the replacement property is sold without another 1031, the deferred gain (including the recapture) becomes taxable.
The exception is death. A property held until the owner's death receives a stepped-up basis under current US tax law (IRC Section 1014). The step-up resets the basis to fair market value at death, eliminating both the deferred capital gain and the deferred depreciation recapture. The heirs inherit a clean basis. This is the structural reason many older owners choose to hold rather than sell — the lifetime 1031 chain followed by step-up at death is the most tax-efficient outcome available under current law.
The political durability of the stepped-up basis is a separate question — it has been periodically proposed for elimination or modification, and any sophisticated tax planning should account for the possibility that this benefit is reduced in future law changes. But under current law, the structure is the gold standard for long-term real estate wealth transfer.
A seller-financed installment sale spreads the capital gain recognition over the life of the note, but depreciation recapture is not spread — it is recognized in full in the year of sale regardless of installment treatment.
For an owner using a seller-carry note, this is a meaningful surprise. The expected tax deferral applies to the capital gain portion of the proceeds. The depreciation recapture is taxable in year one even though the cash isn't received in year one. Sellers structuring installment sales need to plan for this acceleration in the year of sale.
A 1031 exchange in which the seller receives some cash at close (not all proceeds rolled into replacement property) produces "boot" — taxable cash received in an otherwise tax-deferred exchange. Boot is taxed first against the depreciation recapture and then against the capital gain.
A seller who structures a partial 1031, retaining $500,000 in cash from a sale with $900,000 of accumulated depreciation, sees the entire $500,000 boot taxed at the depreciation-recapture rate (effectively 25% federal plus state). The cash retention is more expensive in taxes than the seller expects unless the calculation accounts for the boot-against-recapture priority.
Pull the tax basis and the accumulated depreciation from your accountant before you list, not after the offer is signed. The two numbers determine the difference between gross sale price and net after-tax proceeds. Sellers who plan from accurate inputs make better decisions about whether to sell, when to sell, whether to 1031, and how to structure proceeds. Sellers who plan from estimates often discover at the closing table that the tax bill is materially larger than they assumed.
The depreciation recapture is the line item that most often surprises long-held owners. The capital gains math is intuitive; most owners can roughly calculate it. The recapture math is not intuitive and is rarely calculated until the sale is imminent. The earlier in the sale planning the actual recapture number is known, the better the decisions that follow.
The other thing I tell sellers is that the depreciation recapture liability is often the strongest single argument for considering a 1031 exchange or for holding until step-up. For owners with substantial recapture exposure and limited need for liquid cash, the math frequently supports continued holding or structured deferral over a fully taxable sale.
Depreciation recapture is the tax cost of having taken the depreciation deductions you took for years. It is not a surprise tax; it is the back end of a benefit you've been receiving annually. The owners who understand this build the recapture into their sale planning from the start. The owners who don't are surprised at the closing table by a tax bill larger than they expected. The number is calculable. The work of calculating it should happen before the listing, not after the offer.
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Michael Sterman is Senior Managing Director Investments at Marcus & Millichap, specializing in Los Angeles multifamily transactions.
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