Depreciation Recapture Explained: Complete Guide
Depreciation recapture is one of the most consequential tax concepts for real estate investors and commercial property owners. When you sell a depreciable asset at a gain, the IRS requires you to include a portion of the gain as ordinary income equal to the depreciation you previously deducted. Understanding how depreciation recapture works is essential for accurate exit planning and hold period analysis.
This guide covers the depreciation recapture rules under Section 1245 and Section 1250, explains the applicable tax rates, walks through a calculation example, and addresses how recapture interacts with cost segregation. The goal is a precise, investor-focused reference you can use when modeling property dispositions and long-term tax planning.
TL;DR -- Key Takeaway
What Is Depreciation Recapture?
Depreciation recapture is a tax provision that reverses the tax benefit of prior depreciation deductions when a depreciable asset is sold or otherwise disposed of at a gain. The underlying logic is straightforward: if a taxpayer deducted depreciation that reduced ordinary income in prior years, the IRS treats part of any gain on sale as ordinary income rather than capital gain, effectively recovering the prior tax benefit.
The amount subject to depreciation recapture is generally the lesser of the gain realized or the total depreciation claimed over the holding period. If you sell a property at a loss, there is no recapture. If you sell at a gain smaller than accumulated depreciation, only the actual gain is recaptured.
Depreciation recapture applies to any asset that has been depreciated under the Modified Accelerated Cost Recovery System (MACRS) or earlier depreciation systems. This includes personal property such as equipment and fixtures, land improvements, and real property components. The rules differ depending on whether the asset is classified as Section 1245 property or Section 1250 property.
How Depreciation Recapture Works
When a depreciable asset is sold, the seller calculates the amount realized (sale price less selling costs) and compares it to the adjusted basis (original cost less accumulated depreciation). The difference is the total gain. That gain is then divided into two components: the recapture portion and any remaining capital gain.
The recapture portion equals the depreciation previously claimed, up to the total gain. Any gain above the recapture amount is treated as Section 1231 gain, which may qualify for long-term capital gain rates if the asset was held for more than one year. If total depreciation claimed exceeds the gain, only the gain amount is recaptured as ordinary income.
Table 1: Gain Components on Sale of a Depreciable Asset
| Component | Description | Tax Treatment |
|---|---|---|
| Section 1245 recapture | Depreciation on personal property components | Ordinary income rates (up to 37%) |
| Section 1250 recapture (excess) | Depreciation in excess of straight-line on real property | Ordinary income rates (rare under MACRS) |
| Unrecaptured Section 1250 gain | Straight-line depreciation on real property (MACRS amount) | Maximum 25% rate for individuals |
| Section 1231 gain above recapture | Appreciation above original purchase price | Long-term capital gain rates (if held 1+ year) |
Depreciation Recapture Rules
The depreciation recapture rules are codified primarily in Sections 1245 and 1250 of the Internal Revenue Code. These rules govern how prior deductions are recovered on disposition of property that was depreciated for tax purposes. Understanding which section applies to a given asset class is the foundation of any recapture analysis.
Section 1245 property includes personal property such as equipment, machinery, and fixtures, as well as certain other assets with a recovery period of less than 20 years under MACRS. All depreciation taken on Section 1245 property is subject to recapture at ordinary income rates on sale.
Section 1250 property covers real property, including structures and structural components. Because MACRS uses straight-line depreciation for real property, the excess depreciation (depreciation above straight-line) is typically zero under current law. However, all straight-line depreciation taken on real property accumulates as potential unrecaptured Section 1250 gain, which is taxed at a maximum rate of 25% rather than long-term capital gain rates.
Land is not depreciable and therefore is never subject to depreciation recapture. Only the depreciable portion of the property's cost basis is relevant to the recapture analysis.
Section 1245 vs Section 1250 Recapture
The distinction between Section 1245 and Section 1250 recapture is critical for real estate investors who have performed cost segregation studies. A cost segregation study reclassifies some building components from 27.5 or 39-year real property into 5, 7, or 15-year personal property and land improvements.
Key differences
- Section 1245: Applies to personal property components reclassified through cost segregation (5-year, 7-year) and land improvements (15-year in some cases). All depreciation on these assets is recaptured at ordinary income tax rates on sale.
- Section 1250: Applies to the building shell and structural components that remain on a 27.5 or 39-year schedule. Accumulated depreciation on these assets is subject to the 25% unrecaptured Section 1250 gain rate.
This distinction means that after a cost segregation study, the depreciation pool is split: components on shorter lives generate Section 1245 recapture (ordinary rates) and the building shell generates unrecaptured Section 1250 gain (25% rate). The blended recapture picture is more complex than it would be without a study, which is why advance planning matters. For a detailed look at what to expect from depreciation recapture after a cost segregation study, see the next article in this series.
Recapture Depreciation on Sale: Example
The following depreciation recapture example illustrates how recapture is calculated for a property that received a cost segregation study. Assumptions are simplified for illustration.
Scenario
- Purchase price: $2,000,000 (land: $400,000, depreciable basis: $1,600,000)
- After cost segregation: $320,000 reclassified to 5-year personal property
- Remaining building: $1,280,000 on 39-year schedule
- Hold period: 5 years
- Depreciation taken on 5-year assets: $320,000 (fully depreciated with bonus)
- Depreciation taken on 39-year building: approximately $164,000 ($1,280,000 / 39 x 5)
- Sale price after 5 years: $2,300,000
Adjusted basis at sale: $2,000,000 (original cost) minus $484,000 (total depreciation) equals $1,516,000. Amount realized: $2,300,000. Total gain: $784,000.
Of the $784,000 total gain, $320,000 is Section 1245 recapture (ordinary income rates), $164,000 is unrecaptured Section 1250 gain (25% maximum), and the remaining $300,000 is Section 1231 gain potentially taxed at long-term capital gain rates.
Depreciation Recapture Tax Rates
The depreciation recapture tax depends on both the asset class and the taxpayer's individual circumstances. The table below summarizes the general rate framework. Your actual tax liability will depend on your marginal rates, filing status, state taxes, and the Net Investment Income Tax (NIIT) if applicable.
Table 2: Depreciation Recapture Tax Rate by Asset Class
| Asset Class | Code Section | Recapture Rate |
|---|---|---|
| Personal property (5, 7-year MACRS) | Section 1245 | Ordinary income (up to 37%) |
| Land improvements (15-year MACRS) | Section 1245 | Ordinary income (up to 37%) |
| Residential building (27.5-year) | Unrecaptured 1250 | Maximum 25% |
| Nonresidential building (39-year) | Unrecaptured 1250 | Maximum 25% |
| Appreciation above original basis | Section 1231 | Long-term capital gain (0, 15, or 20%) |
State income taxes may also apply to recapture gain. Many states follow federal treatment, but some states have their own capital gain preferences that may or may not apply to recapture income. For a deeper analysis of the depreciation recapture tax rate and how it is applied in practice, see the dedicated rate guide in this series.
Cost Segregation and Recapture
Cost segregation accelerates depreciation by reclassifying components into shorter asset lives. This increases total depreciation taken in early years, which creates more potential recapture exposure on sale. The recapture is not a new liability from thin air. It is the reversal of prior deductions that provided an earlier tax benefit.
The economic question is whether the early-year benefit from accelerated depreciation exceeds the recapture cost at sale, after accounting for the time value of money, differences in tax rates over time, and available deferral strategies. For many long-hold investors, the present value of the earlier deductions outweighs the future recapture cost.
For investors who plan to sell within a short window, recapture planning becomes more urgent because there is less time for the early deductions to compound. See the guide on strategies to minimize depreciation recapture for a structured approach to recapture planning within a cost segregation context.
Planning for Depreciation Recapture
Effective recapture planning requires building the recapture analysis into the acquisition model before purchasing a property, not just before selling. Knowing the projected recapture exposure at exit helps investors evaluate hold periods, financing decisions, and exchange strategies with more precision.
Key planning levers
- 1031 exchange: A properly structured like-kind exchange can defer both the recapture and the capital gain by rolling basis into a replacement property.
- Hold period: Longer holds allow the time value of early deductions to work in the investor's favor, even if recapture at exit is higher.
- Tax rate planning: Recapture exposure is lower if the taxpayer's ordinary rate at exit is lower. This can result from income changes, retirement, or entity restructuring.
- Installment sales: Spreading gain recognition over multiple years can reduce the rate impact of recapture in some circumstances, although recapture income in Year 1 of an installment sale may be limited under certain rules.
If you are evaluating whether to proceed with a cost segregation study before listing a property, review the analysis on cost segregation before selling a property before making a decision.
Frequently Asked Questions
What is depreciation recapture?
Depreciation recapture is a tax mechanism that requires taxpayers to recognize ordinary income or capital gain on the depreciation deductions previously taken when they sell or dispose of a depreciable asset at a gain. The IRS recaptures those prior deductions through ordinary income tax rates or a special maximum rate, depending on the asset class.
What is the depreciation recapture tax rate?
The rate depends on the asset type. Section 1245 property is recaptured at ordinary income rates, which can reach 37%. Section 1250 real property depreciation in excess of straight-line is also recaptured at ordinary rates, while unrecaptured Section 1250 gain (the remaining depreciation on real property) is taxed at a maximum 25% rate for individuals.
Does cost segregation increase depreciation recapture?
Cost segregation increases the amount of depreciation taken, which increases the potential recapture exposure on sale. The additional depreciation comes from reclassifying components into shorter asset classes. Whether that recapture exceeds the early-year benefit depends on hold period, tax rates at sale, and reinvestment assumptions.
What is a depreciation recapture example?
If you purchase a building for $1,000,000 and take $200,000 of depreciation over several years, then sell the property for $1,100,000, your amount realized exceeds your adjusted basis by $300,000. Of that, $200,000 is recaptured depreciation subject to ordinary rates (for 1245 components) or the 25% rate (for 1250 components). The remaining $100,000 may qualify as a capital gain.
Are there depreciation recapture rules specific to real estate?
Yes. Real property falls under Section 1250, which uses straight-line depreciation. Depreciation in excess of straight-line is rare today but is captured at ordinary income rates if it exists. The unrecaptured Section 1250 gain, representing all MACRS depreciation taken on real property, faces a maximum 25% tax rate. Personal property reclassified through cost segregation falls under Section 1245 and is fully recaptured at ordinary rates.
When does recapture depreciation on sale get triggered?
Recapture depreciation on sale is triggered whenever a depreciable asset is sold or disposed of at a gain. It also applies to partial dispositions, casualty events, and certain like-kind exchanges where boot is received. A 1031 exchange can defer recapture if done correctly, but the basis carries over and the recapture follows the replacement property.
Can 1031 exchanges defer depreciation recapture?
Yes, a properly structured 1031 exchange can defer depreciation recapture by rolling the adjusted basis into a replacement property. The recapture is not eliminated but is deferred until the replacement property is sold outside of another exchange. Partial exchanges or boot received may trigger partial recapture.
How is recapture different from capital gain?
Capital gain reflects appreciation above the original purchase price, while recapture reflects the portion of sale proceeds attributable to prior depreciation deductions. Recapture is taxed at higher rates than long-term capital gains, making it an important planning factor when modeling hold period and disposition strategies.
Does depreciation recapture apply to bonus depreciation?
Yes. If a component was fully depreciated through bonus depreciation, the entire cost basis is at zero. On sale, the full proceeds attributable to that component are subject to recapture at applicable rates. Bonus depreciation accelerates the deduction but does not eliminate the recapture exposure.
Next step: Review how depreciation recapture specifically affects cost segregation outcomes in Cost Segregation and Depreciation Recapture: What to Expect.