Depreciation Recapture

When a rental sells for a profit, the IRS claws back some of the depreciation the owner deducted over the years; that clawback is depreciation recapture. BRRRR investors claim depreciation on the building and rehab each year, and recapture is the bill that comes due at the sale unless the gain is deferred.

US tax rules spread the cost of a residential rental building across 27.5 years, and each year's share can shelter rental income that is still arriving as cash. The purchase price of the building plus the capitalized rehab cost sets the basis being depreciated; land does not depreciate.

On a sale, the gain attributable to depreciation on real property is taxed at up to 25% federally, with the rest taxed as a capital gain. A like-kind exchange can defer both. Cash-out refinance proceeds are not a sale and are not taxed, which is part of why BRRRR investors often refinance instead of selling.

Further reading: Depreciation Recapture on Wikipedia.