When you sell an asset that has been depreciated (expensed over time) for a gain, the amount of the gain attributable to depreciation is taxed as ordinary income, as opposed to a capital gain. For example, lets say you have a rental house with a cost basis of $100,000. While it is rented, you take $20,000 of depreciation expense. You then sell the house for $150,000. Your gain on the sale is $70,000 ($150,000 - ($100,000 - $20,000)). Of the $70,000 gain, for tax purposes you will have a long term capital gain of $50,000 and $20,000 of depreciation recapture, taxed as ordinary income (which for real estate is capped at 25%). Had you sold the house for $90,000, you would have $10,000 of depreciation recapture and no long term capital gain.
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