Thinking about selling a long-held rental? Before you sign that contract, you’ll want to understand how taxes — especially depreciation recapture — impact your bottom line. Scott Ellsworth breaks it down below, and I’ve added a few notes to help you see how this applies to today’s investors.
And remember: Scott will be teaching our Tax Fundamentals Master Class on December 13th — free for MAREI Members. Details at the end.
The Hidden Cost of Selling a Long-Held Property
What are the consequences of selling that property you have held for 15 years? You may walk away with some cash, assuming you haven’t refinanced the property. If you have refinanced the property and taken cash out, you may find yourself owing more in taxes than you get when you sell. By the time you’ve paid off the mortgage and paid all of those taxes the government wants, it could literally cost you to sell your property.
This is the exact surprise that catches investors off guard — you think you’re cashing out, only to watch taxes eat the profit. Refinances mask the problem because you already pulled the equity out years ago.
Depreciation Isn’t “Free Money” — The IRS Wants It Back
Why? Because the depreciation deduction that you take on a rental property is really just temporary—you get to write it off while you own the property, but you have to “recapture” it when you sell.
We all know that for the most part your property doesn’t really depreciate over time. Meaning it does not go down in value. We plan on the property to go up in value.
Well, since it really did not depreciate, the IRS wants you to return the deduction. So, in addition to the capital gain on the property (Sale Price less the purchase price and any improvements you did) all the depreciation has to be added back to income (or recaptured) when you sell the property.
Recapture is the silent villain. Most investors only think about capital gains — but depreciation recapture can hit just as hard, sometimes harder. This is why planning matters.
Hold a Property Long Enough… and You Might Owe Taxes on Almost Everything
If you have held a property for all its depreciable life (27.5 years for residential rentals) then basically the entire sales price, less sales expenses will be taxed. That means that if you have refinanced at 80%, I hope you have kept some of the cash from the refinance. You may very well need it after paying closing costs and the income taxes.
This applies to many long-term Kansas City landlords who bought properties in the early 90s or 2000s. You’re sitting on huge appreciation — and huge depreciation recapture. A sale without a strategy can create a tax bill nobody is ready for.
The Escape Hatch: 1031 Exchanges
There is help, though: a section 1031 exchange provides a way to defer the tax on that gain. You can exchange the property for another larger property or multiple properties. Any cash or net debt relief would be taxed if you get any. It is important to structure the selling of your existing property and the purchase of your new property correctly. There are lots of rules and you will need an independent, trustworthy intermediary to handle the transaction as nothing can flow through your hands. Your tax return filing for the year is critical as well.
1031 Exchanges are one of the most powerful wealth-building tools we have as real estate investors — but also one of the easiest to mess up. Timing, identification windows, intermediaries, paperwork… Scott will walk through all of this in his Master Class.
Why Investors Use 1031 Exchanges Again and Again
A section 1031 Exchange is a great vehicle to defer, or possibly eliminate taxes, on your property. It allows you to use all of your equity in your existing property to buy something bigger instead of paying taxes each time you move up which reduces what you have to invest.
The key word is leverage — keeping 100% of your capital working instead of handing 25–40% to the IRS every time you upgrade to a better property.
About Scott Ellsworth
Scott Ellsworth is a CPA specializing in real estate taxation and accounting. He assists clients all over the country with proper tax compliance and planning for real estate transactions. He can be reached at [email protected]
Want to Learn More From Scott? Join Us on December 13th.
MAREI Master Class: Tax Fundamentals for Real Estate Investors
Saturday, December 13th
8AM–2PM CST
Instructor: Scott Ellsworth, CPA
FREE for MAREI Members
🔗 Register at: MAREI.org/calendar
✔️ IRS red flags (and how to avoid them)
✔️ Depreciation & recapture
✔️ Smart timing strategies
✔️ 1031 exchanges
✔️ Bonus depreciation
✔️ Entity structure
✔️ Year-end tax planning you can actually use
This is one of the most practical, investor-friendly tax classes you’ll attend all year.
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