The “hidden tax” many real estate investors never see coming

If you own investment real estate, you already know how valuable depreciation can be.

It shelters rental income, boosts cash flow, and makes real estate one of the most tax-efficient wealth-building tools out there.

But many investors don’t fully understand what happens when they exit.

When you sell, the IRS wants some of those past deductions back in the form of depreciation recapture.

It’s typically taxed at 25% of the depreciation allotted over the course of ownership (whether you actually claimed it or not). 

The liability can easily swell into the six or seven figures. And yes, it’s in addition to capital gains and state taxes.

One of my clients is a classic buy-and-hold investor.

Over 30 years, he built a $25M real estate portfolio and had never sold a single asset.

Now he’s getting older, wants to simplify life, and “prune” the portfolio. So I helped pencil some numbers on a property he was considering selling.

When he saw the line item for depreciation recapture at 25%, he wasn’t just surprised, he was annoyed and agitated.

He always knew taxes would come due eventually, but he had never truly calculated the exit math because he’d always been in accumulation mode.

We discussed all the following as potential options for him:

• 1031 Exchange

• Delaware Statutory Trust (DST)

• Charitable Remainder Trust (CRT)

• Selling and paying the tax

• Holding indefinitely to get a step-up in basis

Whatever your situation, make sure you understand your full tax liability (including depreciation recapture), before you sell.

Because the IRS never forgets the depreciation you took.