It is an accounting thing. When you have a rental property, it is depreciated yearly. When you sell the property, all of the depreciation is paid back and becomes ordinary income.
The federal government and all states with income tax treat rental property depreciation in the same way.
In the simplest terms, depreciation recapture lets the IRS collect taxes on the financial gain you make from selling an asset like real estate or property. When you buy an asset like a building or a vehicle, the IRS lets you deduct some of the value of that asset as it depreciates over time. This results in you paying fewer taxes in the short term. But if you ever sell that asset, the difference between the sale value of the asset and its depreciated value will be accounted for. This extra income will be taxed on your next tax return, thus “recapturing” the lost taxable income. To understand depreciation recapture more fully, you first have to understand depreciation.
“Depreciation” is most commonly used by taxpayers or businesses to write off the progressively lost value of certain fixed assets, like equipment or real estate. Over time, this allows the taxpayer to benefit and/or earn revenue from that asset’s value without having to pay taxes on that asset at its original price. The “depreciation expense” is the value the asset gradually loses over time. For example, most homes depreciate, as do most cars, because they are used and become less valuable to future buyers. An even better example is a business commercial property.
Once a business owner buys the property, they can use depreciation to write off some of its value as its value decreases with time. But the business owner still earns revenue from the asset, increasing their net income. Although depreciation recapture most often applies to the sale of real estate, it can also apply to other assets like equipment or furniture. Any capital assets are theoretically vulnerable to depreciation recapture under the right circumstances.
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