Depreciation Recapture Explained: What Happens When You Sell
Section 1250 (real property): up to 25% federal recapture on accumulated depreciation | Section 1245 (personal property reclassified via cost-seg): taxed at ordinary income rates (up to 37%) | Capital gains: 0/15/20% federal on appreciation above basis | Recapture only triggers on sale or other disposition — 1031 exchanges defer indefinitely
Depreciation recapture is the tax that catches up with accelerated depreciation when you sell. Every dollar of depreciation you took during ownership reduced your basis; that basis reduction shows up as recapture income at sale, taxed at higher rates than capital gains. Cost-segregation accelerates depreciation aggressively in early years — which generates more total recapture exposure at sale. The math still favors cost-seg in most scenarios (time value of money), but understanding recapture is essential to making the case clearly.
Section 1250 vs Section 1245
Section 1250 governs real property (the building structure, depreciated over 27.5 or 39 years). Recapture on Section 1250 property is capped at 25% federal (the 'unrecaptured Section 1250 gain' rate). Section 1245 governs personal property (5-year and 7-year property reclassified via cost-segregation: furniture, appliances, fixtures). Recapture on Section 1245 property is taxed at ordinary income rates — up to 37% federal. Cost-seg shifts more basis from Section 1250 to Section 1245, which means higher recapture rates on more of the deduction.
The recapture math worked through
The cost-seg approach generates the same total deductions over time, just front-loaded. Front-loading deductions creates time-value benefit: $74K saved in year 1 invested at 7% becomes $107K by year 7. Even with full $74K recapture at year-7 sale, the investor is still ahead by $33K from time value alone. Higher tax bracket investors see proportionally larger benefits.
| Scenario | Year-1 Tax Saved | Recapture at Sale (year 7) | Net Benefit |
|---|---|---|---|
| No cost-seg, normal depreciation | $18K (year-1 deduction at 37%) | $50K total Section 1250 recapture at 25% | Modest |
| Cost-seg + 100% bonus | $74K (year-1 deduction at 37%) | $74K Section 1245 recapture at 37% | Large positive (time value) |
How to reduce recapture exposure
- 1031 exchange. Defer recapture indefinitely by exchanging into replacement property.
- Hold indefinitely. No sale = no recapture. Estate planning step-up in basis at death eliminates accumulated depreciation entirely.
- Installment sale. Spread recapture across multiple tax years, smoothing rate exposure.
- Charitable donation. Donate appreciated real estate to charity for fair-market-value deduction without selling.
- Qualified Opportunity Zone reinvestment. Defer (and partially eliminate) gains by reinvesting in QOZ funds within 180 days of sale.
Bridge to STR + cost segregation
Cost-segregation creates more upfront tax shelter but more recapture exposure at sale. Most investors come out ahead due to time-value of money — front-loaded deductions invested or compounded over the holding period exceed the eventual recapture cost. The math improves further if recapture is deferred via 1031 or eliminated via estate-planning step-up. Don't let recapture concerns prevent cost-seg adoption; understand recapture so you can plan for it. See cost segregation for Airbnb properties and 1031 exchange step-by-step.
Frequently asked questions
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