Depreciation recapture

Depreciation feels like free money while you own a property. It shelters your rental income year after year. The catch arrives at the closing table when you sell: the IRS wants that shelter back. That clawback is called depreciation recapture, and it is the single most underestimated number in a real estate sale.

The logic is straightforward. Depreciation lowered your taxable income during the hold, and it also lowered your basis in the property, your tax cost. A lower basis means a larger gain when you sell. Recapture is the rule that says the part of your gain created by depreciation gets taxed, often at a rate higher than ordinary capital gains.

Recapture is not a penalty; it is the tax code collecting on the deductions it lent you while you owned the property.

Two kinds of recapture, two different rates

This is where most explanations stop too early. There is not one recapture rate. There are two, and cost segregation determines how much of your gain lands in the more expensive one.

The building, the straight-line depreciation on the structure itself, is Section 1250 property. When you sell, the depreciation you took on it comes back as “unrecaptured Section 1250 gain,” taxed at a maximum federal rate of 25%. Higher than the 15% or 20% long-term capital gains rate most investors pay, but capped.

The components a cost-segregation study pulled out, the appliances, flooring, wiring, site work, are Section 1245 property. Their recapture is different and worse. All the depreciation you took on 1245 property, including the giant first-year bonus deduction, comes back as ordinary income, taxed at your marginal rate, which can run to 37%. There is no 25% cap on this piece.

The building’s depreciation recaptures at a capped 25%; the cost-seg components recapture at ordinary rates up to 37%.

The uncomfortable truth about cost segregation

Put those two facts together and you get the seam almost no one selling studies leads with. Cost segregation increases your recapture, and it moves that recapture into the higher-taxed bucket.

Without a study, most of your depreciation is straight-line on the building, recaptured at the capped 25%. Run a study, and you shift a large chunk of that depreciation onto 1245 components, which recapture as ordinary income at up to 37%. So the very move that handed you a $200,000 first-year deduction also guarantees that, at sale, a bigger share of your gain comes back at the higher rate. The study still usually wins, because a deduction today at your full marginal rate, reinvested or deferred, beats a smaller deduction spread over decades. But “the study saves you six figures” is only half the sentence. The other half is that some of it comes due at sale, at a higher rate, unless you never sell in a way that triggers it.

Cost segregation does not just accelerate depreciation; it converts future recapture from the capped 25% rate into ordinary income up to 37%.

The three ways out

Recapture is not inevitable. There are three real ways to defer or erase it, and they are the reason your exit plan belongs in the decision to depreciate aggressively in the first place.

A 1031 exchange defers it. Roll the sale into a like-kind replacement property and both the capital gain and the recapture carry into the new property’s basis. You have not paid the tax; you have moved it forward, and you can keep moving it.

Death erases it. Under current law, when you die your heirs take a basis stepped up to the property’s fair market value. The deferred gain and all the recapture riding with it disappear. Pair a lifetime of 1031 exchanges with that step-up and the recapture you spent decades deferring is never paid by anyone. Estate planners call it swap until you drop.

Timing and losses can soften it. Selling in a lower-income year, or pairing the sale against other losses, can reduce the capital-gain slice, though the 25% unrecaptured 1250 piece runs first and cannot be netted away by an ordinary Section 1231 loss.

The bottom line

• Depreciation lowers your basis, so recapture taxes the gain that depreciation created when you sell.
• Building depreciation recaptures at a capped 25%; cost-seg components recapture as ordinary income up to 37%.
• Cost segregation increases recapture and shifts it into the higher-taxed bucket, a real cost of the strategy.
• A 1031 exchange defers recapture; a stepped-up basis at death can erase it entirely.
• Model recapture before you sell; it is routinely larger than sellers expect.

To weigh recapture against the upfront deduction, read is a cost segregation study worth it. For how a 1031 defers it, see 1031 exchanges and exit planning. For the full picture, start at the depreciation and cost segregation hub.

Last verified August 2026.