What Is Depreciation Recapture? What Rental Investors Owe When They Sell
Depreciation recapture is the tax you owe on prior depreciation deductions when you sell a rental property at a gain. Section 1245 personal property is recaptured at ordinary income rates (up to 37%). Section 1250 real property is taxed at a maximum 25% rate. Both are higher than the long-term capital gains rate on appreciation.
Depreciation is a tax benefit while you hold a property — it reduces your taxable income annually. But when you sell, the IRS partially "recaptures" those deductions by taxing them at higher rates than long-term capital gains on pure appreciation. Understanding recapture is essential for planning your exit strategy.
Section 1245 vs. Section 1250 Recapture
The IRS uses two different recapture rules depending on the type of property:
| Property Type | Code Section | Recapture Rate | Examples |
|---|---|---|---|
| Personal property (5/7-yr MACRS) | §1245 | Ordinary income (up to 37%) | Furniture, appliances, equipment, carpets |
| Land improvements (15-yr MACRS) | §1245 | Ordinary income (up to 37%) | Driveways, pools, landscaping |
| Real property (27.5/39-yr MACRS) | §1250 | Maximum 25% | Building structure |
| Appreciation above original cost | §1231 | Long-term capital gains (0–20%) | All property types |
For investors who used cost segregation and bonus depreciation, the §1245 recapture on personal property is the most significant: furniture and appliances depreciated at 100% in year one are fully recaptured at ordinary income rates when sold. However, this recapture only applies to the depreciation actually deducted — if you hold the property long enough that the assets are fully depreciated under their MACRS lives anyway, the recapture is the same whether you accelerated or not.
How the Numbers Work
Suppose you bought a property for $600,000 and took $200,000 in depreciation over several years (including a cost segregation study). You sell for $700,000 — a $100,000 gain over original cost. The IRS does not treat all of this the same way:
- Your adjusted basis is $600,000 − $200,000 depreciation = $400,000
- Sale price $700,000 − adjusted basis $400,000 = $300,000 total gain
- Of that $300,000: $200,000 is recaptured depreciation (taxed at ordinary or 25% rates), $100,000 is appreciation (taxed at long-term capital gains rates)
Strategies to Minimize Recapture
- 1031 exchange: Exchange into another investment property and defer all recapture and gain indefinitely
- Hold until death: A step-up in basis at death eliminates all accumulated depreciation — recapture never triggers
- Installment sale: Spread the gain over multiple years to smooth the tax impact
- Opportunity Zone reinvestment: Roll proceeds into a Qualified Opportunity Fund to defer and potentially reduce gain
- Loss harvesting: Coordinate the sale year with capital losses elsewhere to offset recapture income
Does Cost Segregation Make Recapture Worse?
This is the most common objection to cost segregation. The answer depends on your situation. If you plan to hold long-term or 1031 exchange, cost segregation does not increase your lifetime tax burden — it accelerates deductions into earlier years where they compound. If you sell in year 2 without a 1031 exchange, you'll pay ordinary-income-rate recapture on the full bonus depreciation amount taken.
For investors with a long hold period and a 1031 exchange strategy, cost segregation is almost always net positive. For investors planning to sell outright within 2 years, the calculation requires more careful analysis.
Plan Your Cost Segregation Strategy
Understanding recapture is part of a complete cost segregation analysis. Get your free estimate — we'll show you both the upside and the full tax picture.
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