🏡 Depreciation Recapture & the Section 121 Exclusion

If you’ve ever rented out a room in your home (hello, Airbnb 👋), claimed depreciation, and now you’re thinking of selling, you’ve probably heard the phrase “depreciation recapture.”

And if you’re also counting on using the Section 121 exclusion to avoid paying capital gains tax, it’s important to understand how the two interact — because they do, and not always in your favor.

Let’s break it all down, the simple, 2025 way.

💡 First: What Is Depreciation Recapture?

When you rent out any portion of your home, the IRS lets you deduct depreciation — essentially spreading the cost of the rental portion of your property over 27.5 years.

Depreciation lowers your taxable rental income each year 💸.

But when you sell the home?
The IRS wants that tax benefit back — this is depreciation recapture.

📌 What you need to know:

• You must pay taxes on all depreciation you claimed, even if you never actually used it.

• Depreciation recapture is taxed at a flat 25% rate.

• It applies only to the rental portion of the home — not the part you lived in.

🏠 Section 121 Exclusion — A Huge Tax Break

Section 121 lets qualifying homeowners exclude:

• Up to $250,000 in gain (single)

• Up to $500,000 (married filing jointly)

To qualify, you must:
✔️ Own the home for at least two years
✔️ Live in it as your primary residence for two of the last five years
✔️ Sell it for a gain

But here’s the twist:
Section 121 does not protect you from depreciation recapture on the rental portion.

🔗 How the Two Interact

If you rented out any part of your home — a room, basement suite, ADU, converted garage — you must allocate the gain between:

1. The part you lived in (eligible for exclusion)

2. The part you rented (not eligible)

Then, recapture must be paid on the rental portion no matter what.

📘 Updated 2025 Example

Purchase price of home: $500,000
Portion rented out: 25% (for 3 years through Airbnb)
Total depreciation taken: $13,500
Sale price: $750,000
Total gain: $250,000

Step 1: Allocate gain

25% of the gain = rental portion
→ 25% × $250,000 = $62,500 rental gain
→ Remaining 75% = $187,500 personal residence gain

Step 2: Apply depreciation recapture

You must recapture all depreciation taken:
$13,500 × 25% = $3,375 tax due

Step 3: Apply Section 121 exclusion

The $187,500 personal residence gain qualifies for the exclusion.
Result: No capital gains tax on the personal portion.

Step 4: What’s taxable?

• The $13,500 depreciation → taxed at 25%

• The $62,500 rental gain → may be taxed at capital gains rates depending on the overall tax picture

🧠 Key Considerations for Homeowners

📉 1. Ending rental use before selling helps

Once you stop renting a portion of the home, depreciation ends, which stops future recapture from accumulating.

💸 2. Recapture is unavoidable

Even if you didn’t actually take depreciation, the IRS treats it as if you did.
(Yes… frustrating. Yes… still true in 2025.)

🧮 3. Keep your square footage allocation accurate

The split between rental and personal use affects:

• Gain allocation

• Recapture

• Your tax liability
  Accurate records save you during an audit.

🤝 4. A tax pro can help you strategize

There may be ways to reduce tax impact — timing, basis adjustments, improvements, or ending rental use strategically.

🎯 Conclusion

The Section 121 exclusion can wipe out a lot of gain when you sell your home — but any portion you rented out brings depreciation recapture into the picture.

Understanding how your gain must be allocated, how recapture works, and how it affects your tax bill is key to avoiding surprises at sale time.

If you’ve ever rented out part of your home, even for a short period, don’t guess — let’s run the numbers together.

👉 Book a call with Lisa Brugman, EA & Associates, and get a clear plan before you sell.