At the broadest level, depreciation benefits from a 1031 exchange in a similar manner to capital gains. The most strategic investors we work with at BlueLion invariably depreciate their real estate assets in conjunction with 1031 exchanges when assets are sold to ensure success.
Under current IRS guidelines (as of June 13th, 2025), any depreciation allowed or allowable on an investment property may be subject to recapture at a maximum rate of 25%. When you sell your property, the IRS requires you to account for all accumulated depreciation you previously claimed (or should have claimed, even if you chose not to do so). Through a 1031 exchange, you defer both the capital gains and the depreciation recapture. However, this deferral will follow you into the replacement property. If you decide to sell that replacement property without initiating another exchange or at a time that doesn’t meet the requirements, you will face both the deferred capital gains tax and recaptured depreciation.
In Maryland, real estate investors commonly use 1031 exchanges to defer federal capital gains and state-level taxes. The process offers a tax advantage, but understanding recapture is key. For instance, if you have owned a commercial building for 10 years and claimed $100,000 in depreciation, that amount becomes “built-in” to your potential recapture. When structuring your exchange, confirm that the replacement property’s purchase price and loan amount are the same or higher than the relinquished property to maintain a full deferral. Partial exchanges may trigger some recapture, so it is crucial to work with a Qualified Intermediary who can guide you in matching the properties’ values and mortgage amounts accurately.
Ultimately, depreciation recapture doesn’t vanish permanently; it moves forward to the next property. Some strategic investors choose to keep using 1031 exchanges until they pass assets to heirs, leveraging the step-up in basis benefits. Additional planning strategies including life estate deeding, revocable trusts, and irrevocable trusts must all be employed together to effectively mitigate tax contribution on intergenerational assets. Always consult with tax advisors, CPAs, or attorneys about your specific situation.
Frequently Asked Questions
1. “How does Maryland treat depreciation recapture for a 1031 exchange?”
Maryland follows the federal guidelines for depreciation recapture. You can defer recapture through a 1031 exchange, but the recaptured amount is deferred, not eliminated entirely. If you eventually sell the replacement property in a non-exchange transaction, the deferred depreciation recapture may be taxed at that time.
2. “Can I use a 1031 exchange to upgrade rental properties without triggering recapture?”
Yes. By following the rules—investing in a replacement property of equal or greater value and using a Qualified Intermediary—you defer capital gains and depreciation recapture. Just remember that once you step out of the 1031 exchange cycle, any deferred recapture may become due.
