Depreciation Recapture When You Sell a Rental Property: What You Owe and How to Plan

Depreciation is one of the most powerful tax tools in real estate — but it's not free money. When you sell a rental property, the IRS recaptures the depreciation you took as a higher-taxed item. Understanding recapture mechanics helps you plan the exit from any investment and assess whether accelerating depreciation (via cost segregation) is the right strategy for your situation.

What Is Depreciation Recapture?

Depreciation reduces your adjusted cost basis in the property. When you sell, your gain is calculated as proceeds minus adjusted basis. The lower your basis (from years of depreciation deductions), the larger your taxable gain at sale. The IRS "recaptures" those deductions by taxing a portion of the gain at rates higher than long-term capital gain rates.

§1245 Recapture: Personal Property and Land Improvements

§1245 applies to tangible personal property (5-year, 7-year assets) and other property (including land improvements) for which you claimed MACRS accelerated depreciation. When you sell, the portion of the gain equal to all depreciation taken on §1245 property is taxed at ordinary income rates — not capital gain rates.

For cost segregation investors who took 100% bonus depreciation on $150,000 of personal property and land improvements, all $150,000 of accumulated depreciation is §1245 recapture at sale — taxed at ordinary rates (up to 37%). This is the direct "payback" of the front-loaded deductions.

§1250 Recapture: Real Property

§1250 applies to depreciable real property (the building structure — 27.5-year or 39-year). The recapture rules for real property are more favorable than §1245: only the depreciation in excess of straight-line is subject to §1250 recapture at ordinary rates. Since residential rental property is already depreciated straight-line (no excess over straight-line), there's typically no §1250 recapture in the traditional sense.

However, there is "unrecaptured §1250 gain" — the portion of the long-term capital gain equal to straight-line depreciation taken on real property — which is taxed at a maximum federal rate of 25% (not the lower 15%/20% LTCG rate). This applies to all depreciation taken on the building structure.

Does Recapture Make Cost Segregation a Bad Deal?

Almost never. The time value of money makes front-loaded deductions extremely valuable even accounting for future recapture. Taking a $150,000 deduction today at a 37% rate saves $55,500 in federal taxes now. Paying 37% recapture tax on $150,000 in 10 years has a present value far less than $55,500 at any reasonable discount rate.

Additionally, if you plan a §1031 exchange, the recapture can be deferred indefinitely by rolling into a replacement property. And if you hold until death, step-up in basis at death eliminates both the gain and the recapture for your heirs.

Minimizing Recapture: Planning Strategies

• §1031 exchange: Defers all gain and recapture by rolling equity into a qualifying replacement property
• Installment sale: Spreads gain (and recapture) over multiple years — but §1245 recapture is recognized fully in year of sale regardless of installment treatment
• Step-up at death: Heirs receive a stepped-up basis eliminating accumulated depreciation recapture entirely
• Opportunity Zone investment: Deferral and partial exclusion of gain if proceeds are invested in a Qualified Opportunity Fund