Depreciation Recapture: The Tax Bill Most Industrial Sellers Don't See Coming

Most owners run the math on a sale the simple way: sale price minus what they paid, times a capital-gains rate. That estimate is almost always too low—because it ignores depreciation recapture, the part of your gain the IRS taxes at a higher rate than the rest. For owners who have held an industrial building for years, it can be the single largest line on the tax bill. Here's how it works and how to plan around it before you list.

What depreciation recapture actually is

Every year you own income-producing industrial property, the IRS lets you deduct a slice of the building's value as depreciation—commercial real property is written off straight-line over 39 years. Those deductions lowered your taxable income while you owned the building, which is a real benefit. But they also lower your adjusted cost basis, dollar for dollar.

When you sell, the IRS “recaptures” that benefit. The portion of your gain that exists only because depreciation shrank your basis is taxed as unrecaptured Section 1250 gain, at a federal rate of up to 25%—higher than the 15–20% long-term capital-gains rate that applies to the rest of the appreciation. You owe it on depreciation you were allowed to take, whether or not you actually claimed it.

Why it surprises people: it isn't tied to appreciation

The trap is that recapture has nothing to do with whether your building went up in value. Even a property that sold for roughly what you paid can generate a sizable recapture bill, because your basis dropped every year you held it. The longer the hold, the more depreciation accumulated—and the bigger the recapture slice waiting at the closing table.

A worked example

Say you bought a multi-tenant industrial park for $3.0M, with about $2.4M allocated to the building (land isn't depreciable). Over a 10-year hold, straight-line depreciation runs roughly $61,500 a year, so you've taken about $615,000 in deductions. Your adjusted basis is now about $2.385M.

You sell for $4.0M. Your total gain is about $1.615M. Of that, the first ~$615,000—the depreciation you took—is unrecaptured Section 1250 gain taxed up to 25% (about $154,000 federal). The remaining ~$1.0M of true appreciation is taxed at the long-term capital-gains rate. On top of both, the 3.8% Net Investment Income Tax can apply, and California taxes the entire gain as ordinary income—there's no preferential state rate—at up to 13.3%. The recapture piece alone is six figures that a back-of-the-envelope estimate would have missed.

How owners plan around it

You can't make recapture disappear if you take cash, but you have real options to defer or soften it:

A 1031 exchange defers all of it. A properly structured 1031 exchange rolls your full gain—appreciation and recapture—into replacement property, so nothing is taxed today. The basis (and the deferred recapture) carries forward. The timelines are strict: 45 days to identify, 180 to close, with a qualified intermediary in place from the start.

An installment sale spreads the gain—but note that depreciation recapture is generally taxed in full in the year of sale, so it doesn't defer the recapture piece the way it defers appreciation.

Timing the year of sale matters when your other income—and therefore your bracket—varies. And for owners exiting management entirely, a 1031 into a passive structure can defer the bill while getting you out of day-to-day operations.

What this means for pricing your sale

None of this should scare you off a sale. Strong industrial pricing and thin supply mean a well-marketed building still trades well. The point is to know your after-tax proceeds before you decide—because the recapture line changes the comparison between holding, refinancing, and selling. A clear-eyed valuation tied to your rent roll, paired with your CPA's depreciation figure, tells you what a sale actually puts in your pocket. If you're weighing a move, it's worth running both numbers together. For the marketing side of that decision, our guide on how to sell your industrial property covers what drives the gross price.

This article is general information, not tax advice. Confirm the figures and strategy for your situation with your CPA or tax advisor.