At 70, He Plans to Sell a Rental He Bought in 2004. The Depreciation He Never Claimed Could Still Be Taxed Because the IRS Counts What He Could Have Taken

Imagine a 70-year-old owner preparing to sell a rental house he has held since 2004. He believes the deal will be straightforward because he never claimed depreciation, so he assumes there is nothing to repay. That mistake could end up costing him tens of thousands of dollars.

Quick Read

• The IRS taxes depreciation as “allowed or allowable,” which means skipping the deduction since 2004 can still cut the adjusted basis by $192,000 and create a $442,000 taxable gain.

• Submitting Form 3115 before the sale can let the owner take the missed depreciation as a catch-up deduction, potentially offsetting about a $96,596 federal tax bill.

• Keeping the property until death would erase the full $442,000 gain and the depreciation recapture because heirs receive a stepped-up basis at fair market value.

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Depreciation is the yearly tax deduction landlords get for wear and tear on a building. For a residential rental, the tax code generally spreads the building’s cost, excluding land, over 27.5 years. When the property is sold, the law reduces the owner’s basis by depreciation that was “allowed or allowable” — in other words, by the amount he could have claimed whether he actually did or not. IRS Publication 551 says it plainly: if a taxpayer did not take a depreciation deduction, the basis must still be reduced by the full amount that could have been taken.

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What the Sale of a 2004 Rental Could Trigger

Assume the following hypothetical numbers: the buyer paid $300,000, with $60,000 allocated to land and $240,000 to the building. The property was rented for about 22 years, no improvements were made, and it sold for $550,000 after selling costs. He and his wife file jointly with $100,000 of other income, and they live in a state with no income tax.

The gain is taxed in layers. The depreciation portion is treated as unrecaptured Section 1250 gain, which is taxed like ordinary income but capped at 25%. At that maximum rate, the tax would be $48,000.

The remaining $250,000 is long-term capital gain and would be taxed at 0%, 15%, or 20% depending on income. At 15%, the tax would be $37,500. Then there is the 3.8% net investment income tax, which applies once modified adjusted gross income exceeds $250,000 for joint filers and $200,000 for most single filers. In this case, that adds $11,096.

The total federal tax bill comes to about $96,596. Even worse, the owner never received the benefit of the $192,000 in deductions. If he had been in the 22% bracket, those missed write-offs would have produced roughly $42,240 in tax savings over the years. He paid full price while owning the property and still owes the recapture now. One IRS rule can quietly erase six figures; this is one of several tax traps retirees often miss.

A Single Form Can Recover Missed Depreciation

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

The most useful time to file is the tax year before the sale or the year of the sale, because the deduction can directly offset the recapture that cannot be avoided. This is the kind of filing best handled by a CPA or enrolled agent. The form is technical, and the value of the catch-up deduction depends on the owner’s other income and the passive-loss rules that apply to rentals.

Why Holding Can Be Better Than Selling

Before listing the house, two alternatives deserve serious consideration:

• A like-kind exchange. Under Section 1031, the owner can exchange the property for another investment property and recognize no gain. The tax is deferred to the replacement property, and he remains a landlord.

• Holding until death. Heirs receive a basis equal to fair market value at the date of death, and the depreciation recapture rule does not apply to a transfer at death. In that case, both the $442,000 gain and the recapture disappear. Estate tax only becomes relevant above a $15,000,000 basic exclusion for 2026 deaths.

If he does not need the money and intends for his children to inherit the property, keeping it may be the better choice, especially if a property manager can handle the day-to-day work. If he wants the cash or wants out, filing Form 3115 before the sale can preserve the catch-up deduction.

Get the Adjusted Basis Before Listing

Before signing with a listing agent, he should ask a tax preparer for the property’s adjusted basis: purchase price plus improvements, minus every dollar of depreciation that was allowed. That one number determines the size of the tax bill, shows how large the catch-up deduction could be, and helps reveal whether holding is better than selling.

The key is not to assume that skipped depreciation means no recapture. The IRS taxes it as though it had been claimed, so the owner may as well take the deduction if he can.

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