I'm a Canadian Selling My US Rental. What Is Depreciation Recapture? The Deduction You Took (or Should Have) Comes Back at 25%

Depreciation is the annual deduction for the wearing out of a rental building: 27.5 years straight-line for residential property. Every dollar of depreciation reduces the owner's basis, so when the property is sold, the gain is larger by the depreciation taken, and the portion of the gain attributable to depreciation is taxed at a higher rate than the rest: up to 25% as unrecaptured section 1250 gain, rather than the 15% or 20% long-term capital gains rate. The rule that surprises Canadian sellers is "allowed or allowable": basis is reduced by the depreciation that could have been claimed, whether or not it was, so an owner who never deducted depreciation still has the recapture and got nothing for it.

Key takeaways

• Depreciation: the building (not the land) is depreciated over 27.5 years on a straight-line basis; furniture and appliances over 5 or 7 years; land improvements over 15. For a non-resident under the section 871(d) election, depreciation is a deduction on Schedule E against rental income.
• Basis reduction: each year's depreciation reduces the owner's adjusted basis. Sale price less adjusted basis is the gain.
• Recapture: the portion of the gain up to the total depreciation allowed or allowable on the building is unrecaptured section 1250 gain, taxed at the owner's ordinary rate up to a maximum of 25%; the rest is long-term capital gain at 0%, 15%, or 20%. Depreciation on personal property (furniture, cost segregation components) is section 1245 recapture at full ordinary rates.
• Allowed or allowable: basis is reduced by the depreciation allowable under the method used, even if the owner did not claim it. An owner who skipped depreciation has the same recapture and no prior deduction; the fix is Form 3115 (a change in accounting method) to catch up the missed depreciation in the year of sale.
• FIRPTA: the buyer withholds 15% of the gross price regardless of recapture; Form 8288-B reduces it to the expected tax including the recapture.
• Canada: Canada has its own optional capital cost allowance; if claimed, it is recaptured as fully taxable income on sale; if not claimed, there is no Canadian recapture. The US tax including the recapture tax is a foreign tax credit.

How depreciation works

The purchase price is allocated between land (not depreciable) and building (depreciable), usually by the assessor's ratio. The building's cost is deducted over 27.5 years: about 3.636% a year. A $500,000 condo with $400,000 allocated to the building produces $14,545 of depreciation a year. Under the 871(d) election, the deduction reduces the net rental income on the 1040-NR; in a loss year, the loss is suspended (passive) and released on sale.

Basis and gain

Adjusted basis is the purchase price plus improvements less depreciation. After ten years, the condo's adjusted basis is $500,000 less $145,450, or $354,550. Sold for $700,000, the gain is $345,450, not $200,000. The extra $145,450 is the depreciation coming back.

The recapture rate

Section 1250 property (the building) depreciated on a straight-line basis has no ordinary-income recapture, but the gain attributable to the depreciation is "unrecaptured section 1250 gain," taxed at the taxpayer's ordinary rate with a ceiling of 25%. For a non-resident with no other US income, the graduated rates apply, so a modest recapture amount may be taxed below 25%. The remaining gain is long-term capital gain at 0%, 15%, or 20% depending on total taxable income.

Section 1245 property (furniture, appliances, and cost segregation components) is recaptured as ordinary income to the extent of the depreciation, at rates up to 37%.

The suspended passive losses from prior years are released in the year of a fully taxable sale and offset the gain, including the recapture.

Allowed or allowable

Section 1016 reduces basis by the greater of the depreciation allowed (claimed) and allowable (what could have been claimed under the proper method). An owner who filed 1040-NRs without depreciation, or who never filed and paid the 30% withholding, still has basis reduced by the allowable depreciation. On sale, the recapture applies as if the depreciation had been taken, and the owner never got the deduction. The remedy is a change in accounting method on Form 3115 filed with the sale-year return, which allows the owner to take all the missed depreciation as a deduction in the sale year (a section 481(a) adjustment), matching the recapture with a current deduction. Without the 3115, the missed depreciation is lost and the recapture stands.

FIRPTA

The buyer withholds 15% of the gross price. Form 8288-B, filed before closing with the computation of the expected tax (capital gain plus recapture), asks the IRS to reduce the withholding to that amount. The 1040-NR for the sale year reports the sale on Form 4797 (Part III computes the recapture) and Schedule D, with the withholding as a payment.

Canada

Canada's depreciation (capital cost allowance) on a foreign rental building is optional, at 4% declining balance. If the owner claimed it on the T776, the recaptured CCA is fully taxable as income in the year of sale (no half inclusion); if not, there is none. The capital gain is computed in Canadian dollars at half inclusion. The US tax on the sale, including the recapture tax, is a foreign tax credit on Form T2209 limited to the Canadian tax on the US-source gain.

Worked example

An Ottawa couple bought a Phoenix rental in 2015 for $400,000 ($320,000 building), filed 1040-NRs with the 871(d) election and claimed depreciation each year ($11,636 a year; $116,360 by the 2025 sale), and sell for $650,000.

• Gain. $650,000 less adjusted basis ($400,000 − $116,360 = $283,640) = $366,360.
• Recapture. $116,360 of unrecaptured section 1250 gain at up to 25%: about $27,000. Remaining $250,000 of long-term capital gain at 15%: $37,500. Arizona non-resident tax at 2.5%. Suspended losses of $8,000 released. Roughly $62,000 of federal tax.
• FIRPTA. $97,500 withheld, or reduced to about $62,000 by Form 8288-B.
• Canada. No CCA claimed; proceeds $890,000 CAD less ACB $520,000 CAD: gain $370,000 CAD, half taxable at Ontario rates, about $99,000, less a credit of about $85,000 CAD for the US federal and Arizona tax.

Had they never claimed depreciation: the same $116,360 of recapture, no prior deductions; Form 3115 with the sale-year return takes the $116,360 as a deduction in 2025 against the gain, restoring the position.

Official sources

"The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate." — Internal Revenue Service, Topic No. 409, Capital Gains and Losses, https://www.irs.gov/taxtopics/tc409

"The disposition of a U.S. real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding." — Internal Revenue Service, FIRPTA Withholding, https://www.irs.gov/individuals/international-taxpayers/firpta-withholding

"You may be able to claim the foreign tax credit if you paid foreign income or profit taxes on income you earned outside Canada and reported on your Canadian tax return." "Complete Form T2209, Federal Foreign Tax Credits, to calculate your federal foreign tax credits." — Canada Revenue Agency, Federal foreign tax credit, https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-40500-federal-foreign-tax-credit.html

Practitioner note

Recapture is the deduction you took coming back at 25%, and for the owner who never took it, it is a tax on a deduction they never got. The Form 3115 in the sale year fixes the second case. For every Canadian selling a US rental, we pull the depreciation history first, compute the recapture, and file the 8288-B with that number rather than the 15%.

See also: For the full sequence of a Canadian move to Florida, see the Canada-to-Florida tax guide, and browse every cross-border tax topic guide, organized by situation.

Next step

Fairlight prepares the depreciation history and recapture computation, the Form 3115 where depreciation was missed, the Form 8288-B, and the sale-year returns in both countries. See cross-border pricing or book a call.