Depreciation recapture in a 1031

Depreciation recapture is the tax on all the depreciation you took over the years, and in a normal sale it can be a brutal surprise, taxed at rates up to 25% for the building and ordinary rates for cost-segregated components. A 1031 exchange defers that recapture along with the capital gain, which is one of its most valuable and least-understood benefits. But the recapture does not disappear; it moves into the new property in a way that quietly reduces the depreciation you can take going forward. Understanding that trade is essential for anyone who cost-segregated the property they are exchanging out of.

The exchange defers recapture, not just gain

Sell a property outright and all your accumulated depreciation is recaptured and taxed in that year. This is the big advantage of exchanging instead: a properly structured 1031 defers both the capital gain and the depreciation recapture at once. For a long-held apartment building or a property you ran a cost-segregation study on, the deferred recapture can be enormous, and deferring it rather than paying it is a large part of why exchanging beats selling.

The deferral is not automatic, though. To defer the recapture along with the gain, you have to do the exchange cleanly: acquire replacement property of equal or greater value, reinvest all the proceeds, and replace the debt. Take boot, or trade into a property type mismatched with what you sold, and you can trigger partial recapture in the exchange year, taxed at those higher recapture rates first. For a cost-segregated building, this is worth watching closely, because the reclassified components carry the harshest recapture.

A 1031 exchange defers depreciation recapture along with the capital gain, a major advantage over a sale, but only if the exchange is clean; boot or a property mismatch triggers recapture now.

The carryover basis, and the depreciation you lose

Here is the part that shocks investors after the exchange closes. The recapture and gain you deferred do not vanish; they get embedded in the basis of your new property as a low “carryover basis.” Your replacement property’s tax basis is not what you paid for it, it is your old property’s adjusted basis, carried over, plus any new money you added.

A worked example makes it stark. Say you exchange out of a property with a $354,000 adjusted basis into a $700,000 replacement, reinvesting everything. You pay $700,000, but your tax basis in the new property is roughly $354,000, not $700,000. The $345,000 gap is your deferred gain and recapture, riding along. And because depreciation is calculated on basis, you now depreciate the new property off that low $354,000 figure, not its $700,000 price. A fresh buyer who paid $700,000 would depreciate the full amount; you get far less. This often comes as a shock to investors who expected to depreciate their new property, and cost-segregate it, as if they had bought it clean.

Your replacement property carries a low carryover basis, so you depreciate it off your old basis, not the price you paid, getting much less depreciation than a fresh buyer would.

Squaring cost segregation with exchanging

This creates a real tension worth naming for aggressive depreciators. Cost segregation front-loads depreciation and increases recapture; a 1031 defers that recapture but hands you a low-basis replacement with limited new depreciation. So the investor who cost-segregates and then exchanges gets the deferral benefit but a smaller depreciation base on the new property. There are ways to add depreciable basis, buying up in value and bringing new cash or debt increases the basis you can depreciate and cost-segregate on the excess, so an investor who trades up meaningfully can still run a fresh study on the added value. The point is to plan the depreciation consequences of the exchange before you do it, not discover the shrunken basis afterward.

The bottom line

• A regular sale recaptures all depreciation in that year; a 1031 defers the recapture with the gain.
• The deferral requires a clean exchange; boot or a property mismatch triggers partial recapture now.
• Deferred gain and recapture ride into the new property as a low carryover basis.
• You depreciate the replacement off that low basis, getting far less depreciation than a fresh buyer.
• Trading up with new cash or debt adds depreciable basis you can cost-segregate.

For the recapture mechanics in general, read depreciation recapture. For the ultimate way to erase it, see death and the 1031. For the full picture, start at the 1031 exchanges and exit planning hub.

Last verified August 2026.