Depreciation recapture is the tax you pay when you sell property on the depreciation you claimed while you owned it. For rental buildings, that portion of the gain is generally taxed at up to 25%. For personal property, such as the 5- and 7-year assets found in a cost segregation study, it's generally taxed at ordinary income rates. You can defer it with a 1031 exchange or avoid it by holding until death.
This content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.
Why recapture exists
Depreciation lowers your taxable income each year and also lowers your tax basis in the property. When you sell, a lower basis means a bigger gain. The IRS "recaptures" the benefit by taxing the part of the gain caused by depreciation at special rates.
Important: the IRS reduces your basis by depreciation allowed or allowable. Even if you never claimed depreciation, you may face recapture as if you had.
The two types of recapture for real estate
| Type | Applies to | Maximum federal rate |
|---|---|---|
| Unrecaptured Section 1250 gain | Buildings and structural parts (27.5- and 39-year property) | 25% |
| Section 1245 recapture | Personal property (5- and 7-year assets like appliances, carpet, equipment) | Ordinary income rates, up to 37% |
The 3.8% net investment income tax may also apply to the gain for higher-income owners. Land improvements (15-year property) have their own rules, so ask your CPA how they're treated in your case.
A simple example
- Bought a rental for $500,000 ($100,000 land, $400,000 building)
- Held 10 years and claimed about $145,000 of straight-line depreciation
- Sold for $650,000 (ignoring selling costs)
| Item | Amount |
|---|---|
| Adjusted basis ($500,000 − $145,000) | $355,000 |
| Total gain ($650,000 − $355,000) | $295,000 |
| Portion from depreciation (taxed at up to 25%) | $145,000 |
| Remaining long-term capital gain (0%, 15%, or 20%) | $150,000 |
In the 15% bracket for capital gains, the federal tax would be up to about $36,250 on the recapture plus $22,500 on the rest, before any net investment income tax.
How cost segregation affects recapture
Cost segregation creates more Section 1245 property, which is recaptured at ordinary rates. That sounds bad, but there are a few things to keep in mind:
- Recapture is based on value at sale. Old carpet and appliances are often worth far less at sale than their original cost, so the gain allocated to them may be small.
- Time value of money. Getting deductions years earlier usually outweighs paying some back later.
- Rate arbitrage. Deductions taken in a high-bracket year and recaptured in a lower-bracket year can be a net win.
Ways to reduce, defer, or avoid recapture
- 1031 exchange. Defers recapture on real property by rolling into new real estate. Personal property needs separate planning.
- Hold until death. Heirs generally get a stepped-up basis, which wipes out the recapture.
- Sell in a low-income year. Ordinary income recapture is taxed at your bracket.
- Allocate the sale price carefully. A supported allocation between land, building, and personal property affects how much is recaptured at each rate.
- Installment sale. Can spread the capital gain, though recapture on personal property is generally taxed in the year of sale.
- Partial asset dispositions. Writing off replaced components along the way keeps your records accurate and can reduce surprises later.
Frequently asked questions
Can I avoid recapture by not taking depreciation?
Does recapture apply to my primary home?
Does a 1031 exchange eliminate recapture?
See what your property may qualify for
Run our 2-minute STR Qualification Quiz or model your Low / Mid / High cost segregation range.
Related guides
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Read guideThis content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.