Depreciation Recapture If Never Claimed: What Happens at Sale

The allowed-or-allowable rule

IRS Publication 946 states the rule plainly: you must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is what you actually deducted. Depreciation allowable is what you were entitled to deduct. If you don't claim depreciation you are entitled to, you must still reduce the basis by the full amount allowable.

A rental home or apartment building is residential rental property, depreciated over 27.5 years, and the depreciation starts when the property is placed in service, that is, ready and available to rent. Each year it was available, the allowable amount built up, claimed or not.

What it means when you sell

Your gain is the sale price less selling costs and your adjusted basis, and the adjusted basis already reflects the allowable depreciation. The part of a long-term gain that comes from that depreciation is unrecaptured section 1250 gain, taxed at your ordinary rate but no more than 25%. The Schedule D instructions figure it from the depreciation allowed or allowable, so the unclaimed amount is in it too.

Take a rental bought in June 2018 for $300,000 plus $6,000 of buying costs, with 80% of the cost in the building, and sold in April 2026 for $420,000. The owner, single with $85,000 of other income, never claimed depreciation.

The left column is what the owner owes. The right column is what many owners expect, but it isn't available: the $69,730.91 of allowable depreciation reduces the basis either way. Meanwhile the owner never got the deductions. At a 22% tax rate, for illustration, those deductions would have been worth about $15,341 over the years. The rental property depreciation calculator works out the allowable amount for your property from the IRS tables.

Fixing it with an amended return

Publication 946 lets you correct depreciation on an amended return in a few situations: the wrong amount came from a mathematical or posting error, or you haven't yet adopted a method of accounting for the property. In the publication's words, you generally adopt a method by using a permissible method on your first return, or by using the same impermissible method on two or more consecutively filed returns. So if only one return so far left the depreciation out, an amended return may still be the fix; a tax professional can confirm it.

An amended return has to be filed by the later of 3 years from the date you filed the original return (a return filed early counts as filed on the due date) or 2 years from when you paid the tax for that year. Years outside that window can't be amended.

Fixing it with Form 3115

If the depreciation was left out of two or more consecutive returns, correcting it is generally treated as a change in accounting method. That generally needs IRS approval, requested on Form 3115, Application for Change in Accounting Method; many depreciation changes qualify for the automatic change procedures described in the IRS's revenue procedures.

The change comes with a section 481(a) adjustment for the unclaimed depreciation: the difference between what you deducted and what was allowable before the year of change. If you deducted nothing, it is the whole allowable amount. A negative adjustment, which is what missed depreciation produces, decreases taxable income and is taken into account in the year of change. In other words, you can claim the missed deductions in one year instead of amending each past return.

Whether Form 3115 is available for your situation, especially in the year you sell, and how it is filed are questions for a tax professional. The rules are detailed, and the procedures are in Revenue Procedure 2015-13 and the later revenue procedures that list automatic changes.

Before you sell a rental with missed depreciation

• Work out the allowable amount. You need the date the property was placed in service, the cost, the land share and any improvements. The depreciation calculator applies the 27.5-year tables and the mid-month convention.
• Estimate the tax on the sale with it. The rental property capital gains tax calculator estimates the depreciation for you and shows the unrecaptured section 1250 gain and the tax on it.
• Ask about recovering the deductions. An amended return or Form 3115 can turn the missed depreciation into deductions that offset part of the cost, if the timing and rules allow.

The rule is the same for a home that later became a rental: from the day the property is available to rent, the depreciation is allowable.

How much depreciation was allowable

The allowable amount follows fixed rules, so you can work it out years later. Residential rental property is depreciated over 27.5 years using the IRS's MACRS tables and the mid-month convention: the property is treated as placed in service in the middle of its first month, and as sold in the middle of the month of sale. Only the building is depreciated. Land never is, so the cost has to be split between the two, for example using the assessor's land and improvement values.

In the example, the depreciable basis is $244,800.00, the building's share of the price and buying costs. The first year, starting in June, allows $4,822.56; each full year after that allows $8,900.93; and the year of sale allows a partial year. By the April 2026 sale the total is $69,725.17, the amount the basis is reduced by whether it was claimed or not. Improvements, such as a new roof, are depreciated separately over the same 27.5 years from the month they are placed in service.