What happens when you sell?
The Depreciation Recapture Playbook for Multifamily Investors
Most multifamily investors understand how powerful depreciation can be while you own a property.
It reduces your taxable income, boosts cash flow, and lets you keep more of what you earn.
But what happens when you sell?
That’s where many investors get caught off guard and where depreciation recapture becomes a surprise line item on your tax return.
But in this article, we’ll walk through what depreciation recapture actually is, how it works in multifamily deals, and four strategies to help you reduce or defer the tax bill that comes with it.
What Is Depreciation Recapture?
When you sell a property for more than its depreciated value, the IRS wants to “recapture” the tax benefit you previously claimed.
In other words: the depreciation deductions you used to offset income during ownership can trigger a tax liability when you exit.
Let’s say you buy a multifamily building for $2 million and take $500,000 in depreciation over several years. If you sell the property for $2.2 million, the IRS doesn’t just tax the $200K of gain. It also taxes the $500K of depreciation you claimed.
That $500K is taxed at a maximum federal rate of 25% (called Section 1250 recapture), plus state taxes.
That means your tax bill on sale could be bigger than expected—especially if you didn’t plan ahead.
Why Recapture Catches Investors Off Guard
Depreciation is one of the biggest benefits of owning real estate. But the tax code is a give-and-take.
You get upfront deductions that reduce your taxable income now. Then the IRS comes back for its piece later.
Most multifamily investors focus on the acquisition and hold period. Recapture only shows up at the end—so it often gets overlooked.
But if you wait until sale to think about it, you miss opportunities to manage it proactively.
The Good News: You Can Reduce or Defer Recapture
Here are four proven strategies multifamily investors use to reduce the impact of depreciation recapture.
1. Use a 1031 Exchange to Defer the Tax
A 1031 exchange lets you sell a property and reinvest the proceeds into another like-kind property, deferring capital gains and depreciation recapture taxes.
You’ll need to follow specific timelines and rules, but if executed correctly, a 1031 lets you keep your money working for you instead of handing a chunk to the IRS.
I’ve worked with syndicators who plan 1031 rollovers years in advance, lining up their next deal before selling the current one. That way, investors can defer both gains and recapture, and compound their returns across multiple deals.
2. Offset Recapture With New Depreciation
Another strategy: reinvest into a new property and front-load depreciation to offset the gain from your sale.
Let’s say you sell a property with $400K of recapture. If you acquire a new multifamily building and run a cost segregation study that generates $400K+ in first-year depreciation, you can use that to offset the tax hit.
Timing matters. You’ll want to place the new property in service in the same tax year as your sale to align the deductions.
This approach works especially well for investors who don’t want to do a 1031 but still want to manage the tax burden.
3. Plan for a Step-Up in Basis
If you hold real estate until death, your heirs receive a “step-up” in basis, resetting the property’s value to its fair market value at the time of inheritance.
That eliminates both capital gains and depreciation recapture.
This is a powerful estate planning tool for high-net-worth investors who plan to pass on real estate to family or heirs.
It’s not about avoiding tax forever, but if your long-term plan includes holding until death, the step-up can be a meaningful part of your wealth transfer strategy.
4. Use Suspended Losses to Offset Gains
Here’s a tactic many investors miss:
If you had passive losses from prior years that were suspended (because they exceeded your passive income), those losses get released when you sell a property.
And they can be used to offset both capital gains and depreciation recapture.
Let’s say you had $200K in passive losses that were sitting on the sidelines. When you sell the property, those losses can come back into play—directly reducing your tax liability.
It’s one more reason to track suspended losses carefully and plan your exits with your CPA.
Final Thoughts
Depreciation recapture isn’t a penalty, it’s just the other side of the benefit you’ve already taken.
But with the right planning, you can reduce or defer those taxes and keep more of your profits.
Whether you’re selling a single asset or managing a portfolio of multifamily deals, thinking ahead about recapture can lead to better after-tax outcomes.
And in a business where every dollar counts, that edge matters.
Source: Multifamily Insiders
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