At 70, He Plans to Sell a Rental He Bought in 2004 — But the IRS Will Tax the Depreciation He Never Claimed

He ignored depreciation deductions for years, thinking that meant there would be nothing to repay when the property was eventually sold. The IRS, however, treats the missed write-offs very differently.

Picture a 70-year-old who has owned a rental house since 2004. He assumes the sale will be simple because he never claimed depreciation, so he expects no recapture. That assumption could end up costing him tens of thousands of dollars.

Depreciation is the annual tax deduction landlords can claim for the wear and tear on a building. For a residential rental, the building’s cost, excluding land, is generally written off over 27.5 years. When the property is sold, tax law reduces the owner’s basis by depreciation that was “allowed or allowable,” meaning the amount he was entitled to deduct whether he actually took it or not. IRS Publication 551 states it plainly: if a taxpayer did not claim depreciation, the basis must still be reduced by the full amount that could have been taken.

Many sellers are caught off guard by this rule. In an Intuit forum for tax professionals, one preparer said a client who sold a rental property had to account for both depreciation taken and depreciation not taken when calculating adjusted basis. The issue can be especially costly when long-held rentals have appreciated sharply.

What the Sale of a 2004 Rental Could Mean

Using hypothetical numbers, assume he paid $300,000 for the home, with $60,000 allocated to land and $240,000 to the building. He rented it for about 22 years, made no improvements, and netted $550,000 after selling costs. He and his wife file jointly, have $100,000 of other income, and live in a state that only taxes income at the federal level.

That gain is taxed in layers. The portion tied to depreciation is known as unrecaptured section 1250 gain, and it is taxed at ordinary income rates but capped at 25%. If the cap applies in full, that part would produce a $48,000 tax bill.

The remaining $250,000 is treated as long-term capital gain and taxed at 0%, 15%, or 20%, depending on income. At 15%, that would come to $37,500. On top of that, the 3.8% net investment income tax applies once modified adjusted gross income exceeds $250,000 for joint filers and $200,000 for most single filers. In this example, that adds $11,096.

Altogether, the federal tax bill would be about $96,596. Even worse, he never actually received the benefit of the $192,000 in deductions he could have claimed. If he had been in the 22% bracket, those missed deductions would have saved roughly $42,240 in taxes over the years. He paid full price while owning the property and still owes the recapture tax at sale.

How to Recover Missed Depreciation

One tax filing can potentially fix two decades of missed depreciation. Leaving depreciation unclaimed is treated as using the wrong accounting method, and the remedy is Form 3115, Application for Change in Accounting Method. That form allows the taxpayer to claim all of the missed depreciation at once as a catch-up deduction, known as a Section 481(a) adjustment, on a current tax return.

The most useful time to file is usually the tax year before the sale or the year of the sale, because the deduction can offset the recapture that cannot be avoided. A CPA or enrolled agent is often the best choice for handling the form, since it is technical and the tax benefit depends on the taxpayer’s other income and the passive-loss rules for rentals.

Why Many Older Owners Think Twice Before Selling

Before listing the house, two alternatives deserve serious consideration:

• A like-kind exchange. Under Section 1031, the owner can swap into another investment property without recognizing gain. The deferred tax carries over to the replacement property, and he remains a landlord.
• Holding the property until death. Heirs receive a basis stepped up to fair market value at death, and the recapture rule does not apply to a transfer at death. In that case, both the $442,000 gain and the recapture disappear. Estate tax would only become relevant above the basic exclusion amount for 2026 deaths.

If he does not need the cash and his children are likely to inherit the property, holding on may be the better move, especially if a property manager can handle the day-to-day landlord work. If he wants to exit or needs the money, filing Form 3115 before the sale can preserve the catch-up deduction.

Ask for the Adjusted Basis Before Listing

Before signing with a real estate agent, he should ask a tax preparer to calculate his adjusted basis: purchase price plus improvements, minus every dollar of depreciation that was allowed. That single number determines the size of the tax bill, the potential catch-up deduction, and whether holding the property is better than selling it.

The main lesson is simple: skipped depreciation does not eliminate recapture. The IRS taxes the amount as though it had been claimed, so it is usually better to take the deduction if possible.