What is depreciation recapture when I sell a property?

Depreciation recapture is the tax owed when property is sold for more than its depreciated basis: the gain attributable to prior depreciation is taxed at ordinary or special rates rather than the long-term capital-gain rate. Accelerated depreciation, including cost segregation, shifts timing rather than creating a permanent deduction, and recapture is the other side of that shift. An exchange or a hold until death changes the outcome.

Key points

Depreciation recapture taxes the portion of sale gain that corresponds to depreciation previously claimed at ordinary or special rates instead of the long-term capital-gain rate.
Each year of depreciation lowers the property's adjusted basis, and gain on sale is measured against that lowered basis.
Cost segregation and bonus depreciation shift deductions earlier rather than removing tax, so accelerated deductions mean a larger recapture at sale.
A 1031 exchange defers recapture together with the rest of the gain by rolling into replacement property.
Holding property until death can reset basis for heirs under the step-up rules, eliminating the deferred gain and the recapture with it.

How does depreciation recapture work?

Each year a property is depreciated, part of its cost is deducted, and that deduction lowers the adjusted basis, the figure the tax on a sale is measured against. When the property is sold, gain equals the sale price minus that lowered basis. The portion of the gain that corresponds to depreciation previously claimed is recaptured, meaning it is taxed at ordinary income rates or at a special rate rather than at the long-term capital-gain rate that applies to the rest of the appreciation.

Two Code sections govern this. Section 1245 recaptures depreciation on personal property and on the short-lived components identified in a cost segregation study, at ordinary rates. Section 1250 governs the building itself, where unrecaptured depreciation is taxed at a capped rate above the long-term capital-gain rate. The sale is reported on Form 4797.

Why is accelerated depreciation a timing shift rather than free money?

A cost segregation study and bonus depreciation pull deductions forward into the early years. That is genuinely valuable, because a deduction today is worth more than the same deduction spread over decades, and it can offset income in the years when the owner needs it most.

But those front-loaded deductions lower basis faster, so more of the eventual gain is subject to recapture, and the components reclassified as short-lived property are recaptured under section 1245 at ordinary rates. The benefit is the time value of money, not a permanent escape from tax. Seeing depreciation this way keeps the first-year excitement of a large deduction from turning into a surprise at the closing table.

When does recapture not come due?

A 1031 exchange defers the gain, including the recapture, by rolling into a replacement property rather than selling outright. The reckoning is postponed rather than paid, and each subsequent exchange rolls it forward again.

If the owner holds the property until death, the step-up rules under section 1014 reset the basis for the heirs to fair market value, which can eliminate the built-in gain and the recapture along with it. Deferring through exchanges during life and a step-up at death is why long-term investors can accelerate depreciation while planning never to pay the recapture themselves.

When is accelerating depreciation the wrong move?

The practical lesson is to plan the exit at the same time as the deduction. Accelerating depreciation on a property the owner intends to sell outright in a few years means accepting a larger recapture bill at that sale. It may still be worth it, but only if the recapture has been modelled against the earlier deduction.

Recapture also cannot be avoided by simply skipping depreciation: the rules reduce basis by the depreciation allowed or allowable, so an owner who never claimed it still faces recapture on what could have been claimed. Before commissioning a cost segregation study or claiming heavy first-year depreciation, have a CPA model the recapture at the expected exit and the exchange or hold alternatives, so the timing benefit is a decision made with eyes open.