Part of our pillar guide: Real Estate Tax Benefits: The Complete Overview →
At a Glance
| What it is | Tax paid at sale on prior depreciation deductions |
| §1250 (real property) | Unrecaptured gain taxed at max 25% federal |
| §1245 (personal / cost-seg) | Recaptured at ordinary income rates (up to 37%) |
| Basis for the tax | Depreciation "allowed or allowable" — claimed or not |
| Plus NIIT? | May add 3.8% net investment income tax on top |
| Defer it | 1031 exchange (carries recapture into replacement) |
| Eliminate it | Step-up in basis at death (IRC §1014) |
| Reported on | IRS Form 4797 and Schedule D |
Every year you own investment real estate, you deduct depreciation — a paper expense that shelters income without costing you a dollar of cash. It is the single most powerful tax benefit real estate offers. But the IRS does not give that benefit away for free.
When you sell, the government “recaptures” the tax value of those deductions. The mechanism is called depreciation recapture, and misunderstanding it is one of the most expensive mistakes real estate investors make at exit — because the recapture bill can be larger than the capital gains bill on the same sale.
The good news: recapture is highly manageable. With the right exit strategy — a 1031 exchange, an installment sale, or simply holding until death — you can defer it for decades or eliminate it altogether. This guide explains the mechanics, the math, and the planning.
Chapter 1
What Is Depreciation Recapture?
When you depreciate a property, you lower its tax basis — the figure the IRS uses to calculate your gain when you sell. Deduct $200,000 of depreciation over the years, and your basis drops by $200,000. That means a bigger taxable gain at sale, even if the property never appreciated.
Depreciation recapture is the rule that says: the portion of your gain that exists only because you took depreciation does not get the favorable long-term capital gains rate. Instead, it is taxed at a higher rate — because you already received a deduction against ordinary income on the way in.
The Core Idea
Depreciation is a timing benefit, not a permanent one. You deduct now at ordinary rates and pay it back later at the recapture rate. The strategy is to control when — and ideally whether — that bill ever comes due.
Chapter 2
Section 1250 vs. Section 1245: The Critical Distinction
Not all recapture is taxed the same way. The rate depends on what kind of property generated the depreciation — and this is exactly where cost segregation changes the calculus.
Section 1250 — Real Property
Buildings & structural components · max 25%
The building itself, depreciated straight-line over 27.5 or 39 years. Because the law no longer allows accelerated depreciation on real property, there is usually no “excess” to recapture as ordinary income.
Instead, the straight-line depreciation becomes unrecaptured §1250 gain, taxed at a maximum federal rate of 25%.
Section 1245 — Personal Property
5/7/15-yr assets & cost-seg components · ordinary rates
Equipment, fixtures, appliances, and the components a cost-segregation study carves out into 5-, 7-, and 15-year schedules.
All depreciation on §1245 property is recaptured at your ordinary income rate — up to 37% federal — to the extent of gain.
Why This Matters
A cost segregation study shifts basis out of slow §1250 property and into fast §1245 property. That accelerates your deductions — but it also means more of your eventual gain is recaptured at ordinary rates instead of the 25% §1250 cap. The strategy still wins for most investors, but only if you plan the exit.
Chapter 3
How Recapture Is Calculated: A Worked Example
Consider an investor who buys a rental property, holds it for ten years, and sells. Here is how the gain splits between depreciation recapture and ordinary capital gain.
$1,000,000 Rental Property · 10-Year Hold
How the $590,000 gain is taxed
* Illustrative only. Assumes top-of-bracket rates, ignores state tax and the 3.8% NIIT, and assumes straight-line §1250 depreciation with no cost-seg §1245 component. Your actual result depends on your bracket, the property, and any cost-segregation election. Consult a qualified tax advisor.
Note that $72,500 of the bill — more than half — is recapture, not appreciation. An investor who only budgeted for capital gains tax would be off by a wide margin. And had this property included a cost-segregation study, part of that depreciation would be §1245, recaptured at 37% rather than 25%.
Chapter 4
The Cost-Segregation Connection
Cost segregation and bonus depreciation let you front-load deductions — pulling years of write-offs into year one. That is enormously valuable while you hold. But it has a recapture consequence that every investor should understand before electing it.
More depreciation taken
Accelerating depreciation lowers your basis faster, which increases the total gain subject to recapture at sale.
Recaptured at ordinary rates
Because cost-seg components are §1245 property, that accelerated depreciation is recaptured at ordinary income rates (up to 37%), not the 25% §1250 cap.
Still a net win — if you plan the exit
The time value of deducting now (at up to 37%) usually beats paying recapture later — especially if you defer it with a 1031 exchange or erase it with a step-up. The danger is electing aggressive cost seg and then selling outright in a few years.
Chapter 5
How to Defer or Eliminate Recapture
1031 Exchange — Defer
A like-kind exchange rolls both your capital gain and your depreciation recapture into the replacement property. Nothing is taxed at the exchange; the deferred recapture simply carries over. Done repeatedly ("swap till you drop"), it pushes the bill out indefinitely.
1031 Exchange Guide →Step-Up in Basis — Eliminate
If you hold until death, IRC §1014 resets your heirs’ basis to fair market value. The accumulated depreciation — and all the recapture attached to it — vanishes permanently. This is the endgame that makes the 1031 "swap till you drop" strategy so powerful.
Step-Up in Basis Guide →Installment Sale — Spread
Selling on an installment note spreads the capital gain across years and can keep you in lower brackets. Note: §1245 ordinary recapture is generally taxed in full in the year of sale even on an installment sale — it cannot be deferred this way — but the §1250 and capital-gain portions can be spread.
Hold Longer / Time the Sale
Recapture is a realization event — it is only triggered when you sell. Holding through a high-income year, or timing the sale into a lower-income year, can reduce the ordinary-rate portion of the bill.
Pitfalls
Common Recapture Mistakes
Budgeting only for capital gains
Investors model a sale at the 20% LTCG rate and forget the depreciation portion is taxed at 25% (or 37% for §1245). On a long-held property, recapture can exceed the capital gains bill.
Skipping depreciation to "avoid" recapture
The IRS taxes depreciation "allowed or allowable." Not claiming it does not avoid recapture — you still owe the tax as if you had taken the deduction. Always claim it.
Aggressive cost seg with a short hold
Front-loading §1245 deductions and then selling outright in 2–3 years can convert a tax win into a wash, because the accelerated depreciation comes back at ordinary rates.
Forgetting the 3.8% NIIT
For higher-income investors, the net investment income tax can stack 3.8% on top of both the recapture and the capital gain — a cost easy to overlook in a quick exit model.
FAQ
Frequently Asked Questions
What is the depreciation recapture tax rate?
For real property (Section 1250), the depreciation you claimed using straight-line is taxed as "unrecaptured Section 1250 gain" at a maximum federal rate of 25% — lower than ordinary rates but higher than the long-term capital gains rate. For personal property and components reclassified through cost segregation (Section 1245), recapture is taxed at your ordinary income rate, up to 37%.
Is depreciation recapture taxed as ordinary income or capital gains?
It depends on the property type. Section 1245 property (5/7/15-year assets, equipment, cost-seg components) is recaptured fully at ordinary income rates. Section 1250 real property depreciated straight-line is "unrecaptured §1250 gain" capped at 25%. Either way, recapture is taxed before the remaining gain is treated as long-term capital gain.
Do I owe recapture even if I did not deduct depreciation?
Yes. The IRS calculates recapture on depreciation "allowed or allowable" — meaning you owe it on the depreciation you could have claimed, whether or not you actually did. This is why investors should always claim depreciation; skipping it does not avoid recapture, it just forfeits the deduction.
Does a 1031 exchange avoid depreciation recapture?
A 1031 exchange defers depreciation recapture along with capital gains — it does not erase it. The deferred recapture carries over into the replacement property and comes due if you ever sell without exchanging again. Investors who "swap till you drop" and hold until death can eliminate it entirely via the step-up in basis.
Does the step-up in basis eliminate depreciation recapture?
Yes. When real estate passes to heirs at death, IRC §1014 resets the basis to fair market value. The accumulated depreciation — and the recapture liability attached to it — is wiped out. This is the foundation of the "buy, borrow, die" and "swap till you drop" strategies.
Continue Learning
Cost Segregation Studies
The strategy that accelerates depreciation — and shifts more of your eventual recapture into the §1245 ordinary-rate bucket. Real dollar examples.
1031 Exchange Explained
The primary tool for deferring recapture. Rules, timelines, and how "swap till you drop" pushes the bill out indefinitely.
Step-Up in Basis at Death
How IRC §1014 erases accumulated depreciation and recapture entirely — the endgame of tax-aware real estate.
Real Estate Tax Benefits Overview
The full system: depreciation, cost seg, gain deferral, and how recapture fits into the bigger picture.