Depreciation Recapture: The Hidden Tax Cost of Selling Depreciable Property
When you sell real property or equipment that you've depreciated, the IRS "recaptures" those deductions at higher tax rates — up to 25% for real estate and ordinary income rates for personal property. Understanding recapture is essential before any sale.
Why Recapture Exists
Depreciation deductions reduce your taxable income each year at ordinary income rates (up to 37%). Without recapture rules, you could claim these deductions at the highest rate and then pay capital gains rates (15%–20%) when you sell — an arbitrage the IRS explicitly closes through recapture provisions.
Recapture forces the gain attributable to depreciation to be taxed at a higher rate than the 15%–20% long-term capital gains rate that would otherwise apply.
Section 1250: Real Property Recapture (25%)
For real property (residential rental, commercial), IRC §1250 recapture taxes "unrecaptured Section 1250 gain" at a maximum rate of 25% — higher than the standard 15%–20% long-term capital gains rate, but lower than ordinary income rates.
Purchase price: $500,000
Total depreciation taken (27.5-year MACRS): $72,727
Adjusted basis: $427,273
Sale price: $650,000
Total gain: $222,727
Unrecaptured §1250 gain (taxed at max 25%): $72,727
Remaining long-term gain (taxed at 15%–20%): $150,000
The $72,727 of depreciation is recaptured at 25%: $18,182 in additional federal tax vs. what you would have paid at 15% ($10,909). Cost: $7,273 in higher taxes on the recapture portion.
Section 1245: Personal Property Recapture (Ordinary Rates)
For personal property (equipment, vehicles, furniture, machinery) depreciated under MACRS or expensed under Section 179 or bonus depreciation, IRC §1245 recapture is taxed at ordinary income rates — up to 37%.
This is the costliest recapture. If you took a $50,000 Section 179 deduction on equipment that saved you $18,500 in taxes at 37%, but you sell the equipment and trigger $50,000 of §1245 recapture — you pay back the full $18,500 (at your current marginal rate) in the year of sale.
Cost segregation accelerates depreciation by reclassifying building components to 5-year, 7-year, and 15-year property. These shorter-lived components are §1245 property — their depreciation is recaptured at ordinary income rates upon sale. The tax benefit front-loads the deductions; the recapture defers the tax cost. If you plan to hold long-term or do a 1031 exchange, cost segregation is almost always beneficial. If you plan to sell soon, model the recapture carefully.
How to Minimize or Defer Recapture
- 1031 Exchange: The most powerful recapture deferral tool — all gain including recapture is deferred when you exchange into like-kind property. Recapture carries over to the replacement property's basis.
- Installment sale (IRC §453): Spreads the recapture gain over multiple years as payments are received — reducing the spike in any single year's taxable income
- Die with the property: Heirs receive a stepped-up basis — eliminating both the capital gain and the unrecaptured depreciation. No recapture is recognized at death.
- Charitable contribution: Donating appreciated property avoids gain recognition, but recapture applies when charitable contribution deduction is calculated — partial recapture reduction
IRC §1245 (gain from disposition of certain depreciable property), IRC §1250 (gain from disposition of certain depreciable real property), IRC §1(h)(1)(D) (25% rate on unrecaptured §1250 gain), IRC §453 (installment sale method). IRS Publication 544 (Sales and Other Dispositions of Assets).
Genie calculates your total recapture exposure on any sale — separating §1245 personal property recapture, §1250 real property recapture, and the remaining capital gain — with after-tax proceeds for each exit scenario.
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