Depreciation Recapture When You Sell: Section 1245 vs Section 1250 Tax Breakdown
Every dollar of depreciation you took during ownership gets sorted into three tax buckets at sale. Most investors do not know which bucket hits hardest until the CPA sends the bill.
Matthew Gigantelli
Lead Cost Seg Engineer · ASCSP M009-25
Cost segregation accelerates depreciation into the early years of ownership. That is the whole point. But acceleration creates a tax liability that sits dormant until you sell the property, and when that liability surfaces, it does not arrive as a single number. It arrives as three separate tax layers, each governed by different IRC sections, each taxed at a different rate. The total recapture bill depends on which assets generated the depreciation, how long you held them, and what your income looks like in the year of sale. This article breaks down exactly how the gain splits, what each layer costs, and why cost segregation still wins even after you account for the recapture.
The Three Tax Layers at Sale
When you sell a depreciated property at a gain, the IRS does not tax the entire gain at the capital gains rate. Instead, it separates the gain into layers based on the type of depreciation that was taken. Each layer has its own maximum rate.
Layer 1: Ordinary Income Recapture (Section 1245 + Section 1250(a) Excess)
What it covers: All depreciation taken on Section 1245 tangible personal property, including 5-year property (carpeting, appliances, specialized electrical, decorative fixtures) and 7-year property (office furniture, certain equipment), plus the portion of accelerated depreciation on 15-year Section 1250 land improvements (parking lots, sidewalks, landscaping, fencing) that exceeds straight-line depreciation under IRC Section 1250(a).
Tax rate: Ordinary income rates, up to 37% federal (2026 rates). This is the most expensive recapture layer.
How it works: Under IRC Section 1245, 100% of depreciation claimed on 5-year and 7-year personal property is recaptured as ordinary income. Under IRC Section 1250(a) and (b), 15-year land improvements are Section 1250 real property, so only "additional depreciation" (the excess of 150% declining balance or bonus depreciation over 15-year half-year straight-line depreciation) is recaptured at ordinary income rates.
Layer 2: Unrecaptured Section 1250 Gain (25% Maximum)
What it covers: Straight-line depreciation taken on the 27.5-year residential or 39-year commercial building structure, plus the straight-line portion of depreciation taken on 15-year Section 1250 land improvements.
Tax rate: Maximum 25% federal. If your ordinary income tax rate is below 25%, you pay the lower rate instead.
How it works: Under IRC Section 1(h)(1)(E) and Section 1250, real property depreciation up to the straight-line amount is taxed at a maximum 25% federal rate ("unrecaptured Section 1250 gain" on Schedule D). For investors in the 32% or higher brackets, this 25% cap saves up to 12 percentage points compared to ordinary income recapture.
Layer 3: Long-Term Capital Gain (0/15/20%)
What it covers: The appreciation in property value above your original purchase price. This is the "true" gain, not the recapture of depreciation.
Tax rate: 0%, 15%, or 20% depending on taxable income. Most investors selling commercial property fall into the 15% or 20% bracket.
How it works: After recapture is calculated, the remaining gain (sale price minus original cost basis, not adjusted basis) is taxed at long-term capital gains rates, assuming you held the property for more than one year.
Critical Ordering Rule
The IRS applies these layers in order. Ordinary recapture (Section 1245 personal property plus Section 1250(a) excess over straight-line on 15-year land improvements) is calculated first. Then unrecaptured Section 1250 gain is calculated on the straight-line 15-year and building depreciation. Only after both recapture layers are satisfied does the remaining gain qualify for long-term capital gains rates.
Worked Example: $1M Property With Cost Segregation
Let us walk through a complete example. This is the math your CPA will do at sale, but most investors never see it until closing.
Setup
Purchase price: $1,000,000
Land allocation (20%): $200,000 (not depreciable)
Depreciable basis: $800,000
Cost segregation reclassification: $120,000 moved to 5-year (§ 1245 personal property) and $80,000 moved to 15-year (§ 1250 land improvements)
Remaining building basis: $600,000 (27.5-year residential § 1250 real property)
Holding period: 7 years
Sale price: $1,400,000
Bonus depreciation assumed: Standard MACRS rates without bonus depreciation (to isolate the cost segregation reclassification benefit)
Note on bonus depreciation: This example uses standard MACRS recovery rates without bonus depreciation to isolate the impact of cost segregation reclassification alone. With bonus depreciation, Year 1 deductions and the resulting NPV advantage would be larger. The allowance is 100% for qualified property acquired and placed in service after January 19, 2025, and 40% for property acquired before January 20, 2025 and placed in service in 2025, so the acquisition date determines how much larger. The analysis below represents the conservative case.
Step 1: Calculate Total Depreciation Taken
| Asset Class | Basis | Annual Depr. | 7-Year Total | IRC Recapture Treatment |
|---|---|---|---|---|
| 5-year property (fixtures, appliances, carpeting) | $120,000 | 200% DB HY | $120,000 | Section 1245 (100% ordinary recapture) |
| 15-year land improvements (parking, landscaping, site work) | $80,000 | 150% DB HY | $39,848 | Section 1250 ($5,181 § 1250(a) excess ordinary; $34,667 straight-line at 25% cap) |
| 27.5-year building (structural components) | $600,000 | $21,818 | $152,727 | Section 1250 (25% Unrecaptured § 1250 cap) |
| Total | $800,000 | $312,575 |
Note: 5-year MACRS property is fully depreciated by year 6 (using the half-year convention). 15-year land improvements use 150% declining balance with the half-year convention ($39,848 recovered over 7 years), compared with $34,667 under 15-year half-year straight-line (6.5 / 15 of $80,000), leaving only $5,181 of IRC § 1250(a) additional depreciation subject to ordinary recapture. The 27.5-year building uses straight-line depreciation at $21,818/year.
Step 2: Calculate Adjusted Basis and Total Gain
Original cost basis: $1,000,000
Less total depreciation taken: ($312,575)
Adjusted basis at sale: $687,425
Sale price: $1,400,000
Less adjusted basis: ($687,425)
Total gain recognized: $712,575
Step 3: Split the Gain Into Three Layers
| Tax Layer | Amount | Max Federal Rate | Federal Tax |
|---|---|---|---|
| Layer 1: Ordinary recapture (5-yr § 1245 $120,000 + 15-yr § 1250(a) excess $5,181) | $125,181 | 37% | $46,317 |
| Layer 2: Unrecaptured Section 1250 gain (15-yr straight-line $34,667 + building $152,727) | $187,394 | 25% | $46,849 |
| Layer 3: Long-term capital gain (appreciation above original cost) | $400,000 | 20% | $80,000 |
| Total | $712,575 | $173,166 |
The effective federal tax rate on the total gain is 24.3%. That is meaningfully higher than the 20% rate many investors assume when they think "capital gains," though separating the straight-line portion of 15-year land improvements into the 25% Unrecaptured Section 1250 pool saves $4,160 in federal tax compared with mistakenly treating all 15-year depreciation as Section 1245.
Why the Ordinary Recapture Layer Looks Worse Than It Is
The $125,181 in ordinary recapture generates $46,317 in federal tax at 37%. That sounds painful. But remember: that accelerated depreciation saved you taxes at 37% in Years 1 through 6, and $34,667 of your 15-year land improvement depreciation was deducted at 37% during ownership but is only recaptured at the 25% Unrecaptured Section 1250 cap at exit (a permanent 12-percentage-point rate arbitrage). Combined with the time value of the deductions at a 7% discount rate, cost segregation creates both a multi-year interest-free loan from the IRS and a rate-arbitrage benefit on the straight-line portion of 15-year land improvements.
NIIT: The Fourth Layer Nobody Expects
The three-layer model is incomplete without the Net Investment Income Tax under IRC Section 1411. The NIIT is a 3.8% surtax that applies to passive net investment income, including all three gain layers for passive investors, when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). Active Real Estate Professionals (REPS) who materially participate in the rental activity are generally exempt from the 3.8% NIIT under Treas. Reg. § 1.1411-4(g)(7).
For passive commercial real estate investors selling a property at a meaningful gain, MAGI will exceed the threshold, meaning the 3.8% NIIT stacks on top of every layer:
| Tax Layer | Base Rate | + NIIT (3.8%) | Effective Federal Rate |
|---|---|---|---|
| Ordinary recapture (§ 1245 + § 1250(a) excess) | 37.0% | 3.8% | 40.8% |
| Unrecaptured Section 1250 gain | 25.0% | 3.8% | 28.8% |
| Long-term capital gain | 20.0% | 3.8% | 23.8% |
The 28.8% Trap
Many investors and even some CPAs quote the Section 1250 recapture rate as "25%." In practice, for any passive investor with MAGI above the NIIT threshold, the effective rate on unrecaptured Section 1250 gain is 28.8%. On the $187,394 of straight-line Section 1250 depreciation in our example, that is an additional $7,121 in tax that does not show up in simplified recapture calculators. Always model the NIIT when projecting sale proceeds.
Applying NIIT to our worked example:
Federal tax before NIIT: $173,166
NIIT (3.8% on $712,575 total gain): $27,078
Total federal tax with NIIT: $200,244
Effective federal rate with NIIT: 28.1%
State Tax Stacking: Where Recapture Gets Brutal
Federal recapture rates are only part of the picture. State income taxes stack directly on top, and several high-tax states do not offer preferential rates for capital gains or recapture. California is the worst case: it taxes all gain categories, including capital gains and recapture, at ordinary income rates with no preference whatsoever.
| Tax Layer | Federal + NIIT | California (13.3%) | New York (10.3%) | New Jersey (10.75%) | Texas / Florida (0%) |
|---|---|---|---|---|---|
| Ordinary recapture (§ 1245 + § 1250(a)) | 40.8% | 54.1% | 51.1% | 51.6% | 40.8% |
| Unrecaptured Sec. 1250 gain | 28.8% | 42.1% | 39.1% | 39.6% | 28.8% |
| Long-term cap gain | 23.8% | 37.1% | 34.1% | 34.6% | 23.8% |
California: Ordinary Recapture at 54.1%
A passive California investor who did cost segregation and sells at a gain faces an effective rate of 54.1% on the ordinary recapture layer: 37% federal + 3.8% NIIT + 13.3% California (which provides no capital gains preference). On $125,181 of ordinary recapture, that is $67,723 in combined tax on Layer 1 alone. This is why California investors must be especially disciplined about exit strategy planning.
Applying the full California stack to our $1,400,000 sale example:
| Tax Layer | Amount | CA Combined Rate | Total Tax |
|---|---|---|---|
| Ordinary recapture (§ 1245 + § 1250(a) excess) | $125,181 | 54.1% | $67,723 |
| Unrecaptured Section 1250 gain | $187,394 | 42.1% | $78,893 |
| Long-term capital gain | $400,000 | 37.1% | $148,400 |
| Total (California) | $712,575 | $295,016 |
The California investor pays $295,016 on a $712,575 gain, an effective blended rate of 41.4%. Compare that to a Texas investor at $200,244 (28.1% effective). The state tax alone adds $94,772 to the sale tax bill.
Cost Seg vs No Cost Seg: Who Wins at Exit?
The common objection to cost segregation is: "You're just going to pay it back when you sell." This is mathematically incomplete. Let us compare the same property with and without cost segregation, holding everything else constant.
| Metric | With Cost Seg | Without Cost Seg | Difference |
|---|---|---|---|
| Total depreciation (7 years) | $312,575 | $203,636 | +$108,939 |
| Year 1 depreciation (standard MACRS without bonus) | $49,818 | $29,091 | +$20,727 |
| Tax savings from depreciation (37%) | $115,653 | $75,345 | +$40,308 |
| Total gain at sale | $712,575 | $603,636 | +$108,939 |
| Federal tax at sale (incl. NIIT) | $200,244 | $153,847 | +$46,397 |
| Net tax difference (nominal) | -$6,089 | ||
| NPV of timing benefit (7% discount, standard MACRS) | +$15,536 to +$32,960 | ||
| Net advantage of cost seg (NPV) | +$9,447 to +$26,871 | ||
The Verdict
Even in a conservative 7-year hold with full taxable recapture and standard MACRS recovery rates without bonus depreciation, cost segregation produces a positive net present value advantage of $9,447 (rising to +$26,871 when electing 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, compared with 40% for property acquired before January 20, 2025). The additional recapture tax at sale is more than offset by the time value of accelerated tax savings received in Years 1 through 6 plus the 12-percentage-point rate arbitrage on the straight-line portion of 15-year land improvements.
Want to run this analysis on your own property? Use the interactive Section 1245 vs. Section 1250 Recapture & Hold-Period Calculator below, or generate a full property-specific engineering estimate in our free cost segregation calculator.
Depreciation Recapture Calculator (Section 1245 vs. 1250 & Hold-Period NPV)
Model all three sale tax layers (Section 1245 ordinary recapture on 5-year personal property plus Section 1250(a) excess over straight-line on 15-year land improvements, Unrecaptured Section 1250 gain at the 25% cap, and Long-Term Capital Gain) across 45 expert-maintained allocation bands.
Planning estimate using midpoint 5-year (§ 1245 personal property) and 15-year (§ 1250 land improvement) MACRS allocations from the Modern CFO 45-band benchmark configuration and a 7% annual time-value discount rate. Under IRC § 1250(a), only 15-year depreciation in excess of straight-line is recaptured at ordinary rates, while straight-line 15-year and building depreciation fall under the 25% Unrecaptured Section 1250 cap. Under post-TCJA IRC § 1031(a)(1) and § 1245(b)(4), a 1031 exchange defers gain and recapture only to the extent relinquished real property is exchanged for qualifying like-kind replacement real property with sufficient replacement Section 1245/1250 real property and no non-like-kind personal property or boot.
5-Year (§ 1245) vs. 15-Year (§ 1250 Land Improvement) Allocation Bands by Property Type
Under IRC § 1245(a)(3) and § 1250(c), 5-year personal property is subject to full Section 1245 ordinary-income recapture, whereas 15-year land improvements are Section 1250 depreciable real property where only accelerated depreciation in excess of straight-line is recaptured at ordinary rates under IRC § 1250(a) (and the straight-line portion falls under the 25% Unrecaptured Section 1250 cap). The table below pulls the published allocation bands from our Modern CFO Cost Segregation Allocation Benchmarks (maintained by Lead Engineer Matthew Gigantelli, ASCSP M009-25, drawing on five years and approximately 8,000 studies reviewed or completed):
| Property Type | 5-Year Band (IRC § 1245 Personal) | 15-Year Band (IRC § 1250 Land Imp.) | Total Short-Life Accelerated Band | 27.5 / 39-Yr Building (IRC § 1250) |
|---|---|---|---|---|
| Townhouse / Rowhouse | 16% - 20% | 2% - 5% | 18% - 25% | 75% - 82% |
| Standalone Single Family | 16% - 22% | 8% - 12% | 24% - 34% | 66% - 76% |
| Residential Condo Unit | 33% - 40% | 0% - 0% | 33% - 40% | 60% - 67% |
| Accessory Dwelling Unit (ADU) | 14% - 20% | 2% - 8% | 16% - 28% | 72% - 84% |
| Cabin / Cottage | 12% - 16% | 2% - 6% | 14% - 22% | 78% - 86% |
| Small Multi-Family (2-4 units) | 18% - 24% | 6% - 10% | 24% - 34% | 66% - 76% |
| Medium Multi-Family (5-20 units) | 16% - 22% | 6% - 10% | 22% - 32% | 68% - 78% |
| Apartment Complex (with Clubhouse) | 18% - 24% | 12% - 16% | 30% - 40% | 60% - 70% |
| Apartment (basic amenities) | 18% - 22% | 6% - 10% | 24% - 32% | 68% - 76% |
| Mid-Rise Apartment (≤6 stories) | 14% - 20% | 4% - 6% | 18% - 26% | 74% - 82% |
| High-Rise Apartment (7+ stories) | 14% - 18% | 2% - 4% | 16% - 22% | 78% - 84% |
| Mixed-Use (Apts + Retail) | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Low-Rise Office (<4 stories) | 12% - 20% | 8% - 12% | 20% - 32% | 68% - 80% |
| Mid-Rise Office (5-12 stories) | 12% - 20% | 6% - 10% | 18% - 30% | 70% - 82% |
| High-Rise Office (13+ stories) | 10% - 16% | 2% - 6% | 12% - 22% | 78% - 88% |
| Office Park / Campus | 14% - 22% | 12% - 16% | 26% - 38% | 62% - 74% |
| Office Condo Unit | 28% - 42% | 0% - 0% | 28% - 42% | 58% - 72% |
| Converted House Office | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Medical Office Building | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Medical Office Condo | 28% - 42% | 0% - 0% | 28% - 42% | 58% - 72% |
| Flex Office / Warehouse | 5% - 12% | 10% - 16% | 15% - 28% | 72% - 85% |
| Retail Strip Center | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Shopping Center / Power Center | 14% - 22% | 12% - 16% | 26% - 38% | 62% - 74% |
| Retail Condo Unit | 28% - 42% | 0% - 0% | 28% - 42% | 58% - 72% |
| Standalone Retail | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Gas Station (Fuel Only) | 32% - 42% | 58% - 68% | 100% - 100% | 0% - 0% |
| Gas Station (with C-Store) | 27% - 34% | 53% - 66% | 80% - 100% | 0% - 20% |
| Restaurant - Quick Service | 22% - 32% | 8% - 12% | 30% - 44% | 56% - 70% |
| Restaurant - Full Service | 20% - 30% | 8% - 12% | 28% - 42% | 58% - 72% |
| Automotive Repair | 16% - 24% | 10% - 14% | 26% - 38% | 62% - 74% |
| Auto Dealership | 16% - 24% | 12% - 16% | 28% - 40% | 60% - 72% |
| Car Wash | 28% - 42% | 58% - 62% | 90% - 100% | 0% - 10% |
| Assisted Living / Senior Housing | 14% - 22% | 10% - 16% | 24% - 38% | 62% - 76% |
| Daycare / Childcare Center | 14% - 22% | 10% - 16% | 24% - 38% | 62% - 76% |
| Hotel (Full Service) | 16% - 24% | 10% - 14% | 26% - 38% | 62% - 74% |
| Motel (Limited Service) | 14% - 22% | 8% - 12% | 22% - 34% | 66% - 78% |
| Resort | 16% - 24% | 10% - 16% | 26% - 40% | 60% - 74% |
| RV Park / Campground | 12% - 20% | 20% - 32% | 32% - 52% | 48% - 68% |
| Country Club | 14% - 22% | 10% - 14% | 24% - 36% | 64% - 76% |
| Industrial Facility | 5% - 12% | 10% - 16% | 15% - 28% | 72% - 85% |
| Warehouse / Distribution Center | 5% - 12% | 10% - 16% | 15% - 28% | 72% - 85% |
| Self-Storage - Premium Climate-Controlled | 14% - 26% | 8% - 12% | 22% - 38% | 62% - 78% |
| Self-Storage - Standard Mixed | 16% - 28% | 10% - 14% | 26% - 42% | 58% - 74% |
| Self-Storage - Basic Drive-Up | 12% - 24% | 20% - 34% | 32% - 58% | 42% - 68% |
| Self-Storage - Economy / Converted | 10% - 18% | 18% - 28% | 28% - 46% | 54% - 72% |
Important: These Figures Exclude Study Costs
A cost segregation study on a $1,000,000 property typically costs $7,000 to $12,000 at traditional firms (or $1,200 to $2,500 residential / $3,000 to $6,000 commercial at Modern CFO). On a 7-year hold under standard MACRS without bonus depreciation, the $9,447 pre-fee NPV advantage (or $26,871 when electing 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, vs. 40% if acquired before January 20, 2025) is reduced dollar-for-dollar by the after-tax study cost, meaning a $1,500 to $2,500 Modern CFO residential study preserves substantial net positive NPV whereas an overpriced $10,000+ traditional fee can erase the standard-MACRS advantage entirely. Cost segregation does not make financial sense for every property, particularly those with depreciable basis under $300,000 or planned holds under 3 years without a qualifying 1031 exchange. Always model the full cost including study fees before proceeding.
Without Cost Seg: Recapture Still Happens
A critical point that many investors miss: depreciation recapture applies whether or not you did a cost segregation study. If you took straight-line depreciation on the full building for 7 years, you have $203,636 in accumulated depreciation. At sale, 100% of that is subject to unrecaptured Section 1250 gain at up to 25% (plus NIIT if passive). The question is never "does recapture happen?" It always happens. The question is whether you maximized the benefit of the depreciation before recapture came due.
The Partial Asset Disposition Angle
If you perform renovations during ownership, Partial Asset Disposition (PAD) under Treasury Regulation 1.168(i)-8 lets you write off the remaining basis of demolished or replaced components in the year of renovation. This creates a current-year deduction and simultaneously reduces your depreciable basis, which means less depreciation recapture at sale.
How PAD Reduces Future Recapture
Suppose you replace the HVAC system (originally allocated $40,000 in the cost seg study) in Year 4. Under PAD, you deduct the remaining $30,545 of undepreciated basis as a loss in Year 4. The new HVAC system starts a fresh depreciation schedule. At sale, the old $40,000 allocation is no longer in your depreciable basis, which means $30,545 less recapture. PAD does not just accelerate deductions during ownership. It structurally reduces the recapture bill at exit.
For a complete walkthrough of the mechanics, see our Partial Asset Disposition ultimate guide.
Exit Strategies That Reduce or Eliminate Recapture
The recapture bill is not inevitable. Several exit strategies can defer, reduce, or completely eliminate it.
1031 Like-Kind Exchange: Real Property Deferral Rules
Under post-TCJA IRC Section 1031(a)(1), like-kind exchanges apply strictly to real property. A properly structured 1031 exchange defers capital gains and Section 1245/1250 recapture to the extent the relinquished real property is exchanged for qualifying like-kind replacement real property with sufficient replacement Section 1245/1250 real property and no taxable boot. However, under IRC Section 1245(b)(4), if non-like-kind Section 1245 personal property is transferred in the exchange without qualifying replacement Section 1245 real property, ordinary recapture can be triggered in the year of the exchange.
Investors who structure compliant real-property 1031 exchanges and coordinate personal-property valuations with their CPA can defer real-property recapture across successive exchanges. Combined with cost segregation on each replacement property's excess basis, this creates a powerful compounding depreciation shield.
For details on cost segregation within exchange transactions, see our guide on 1031 exchange and cost segregation strategy.
Stepped-Up Basis at Death: Complete Elimination
This is the most powerful provision in the tax code for real estate investors. Under IRC Section 1014, when a property owner dies, heirs receive the property at its current fair market value, not the decedent's adjusted basis. This step-up eliminates all accumulated depreciation recapture, both Section 1245 and Section 1250.
Example: The Buy-Hold-Die Strategy
Our $1,000,000 property with $312,575 in accumulated depreciation and a fair market value of $1,400,000 at the owner's death. The heirs receive a stepped-up basis of $1,400,000. If they sell immediately, the gain is zero. The $312,575 in depreciation taken during the owner's lifetime, the $400,000 in appreciation, and the $200,244 in federal tax liability all disappear. This is why the "buy, depreciate, 1031, depreciate again, die" strategy is one of the most tax-efficient wealth transfer approaches in real estate.
Installment Sale: Partial Deferral With a Catch
Installment sales under IRC Section 453 allow you to spread capital gains recognition over the years you receive payments. However, IRC Section 453(i) contains a critical exception: all depreciation recapture must be recognized in the year of sale, regardless of how little cash you actually receive in Year 1.
The 453(i) Trap
Under IRC Section 453(i), all Section 1245 and Section 1250(a) ordinary recapture income ($125,181 in our example, generating $51,074 in federal tax and NIIT) must be recognized in the year of sale regardless of cash received, and total federal tax with NIIT across the full $712,575 sale gain is $200,244 ($105,043 on the $312,575 of combined ordinary recapture and Unrecaptured Section 1250 depreciation layers, plus $95,200 on the $400,000 long-term capital gain). Sellers who take small down payments without modeling Year-1 recapture recognition can face a severe cash crunch in the year of closing.
For more on the intersection of seller financing and recapture, see our guide on seller financing and cost segregation.
Opportunity Zone Reinvestment
Investing capital gains into a Qualified Opportunity Fund (QOF) under IRC Section 1400Z-2 can defer and partially reduce capital gains. If the QOF investment is held for at least 10 years, all appreciation in the QOF investment is tax-free. However, the original depreciation recapture portion follows the same rules as any other gain: it can be deferred by investing in the QOF but must eventually be recognized. This strategy works best for the capital gain layer rather than the recapture layers.
Important timing note: The original OZ gain deferral required investment in a Qualified Opportunity Fund by December 31, 2026, with deferred gain recognized by the same date. For investors considering this strategy in 2026, consult your tax advisor on current legislative status and remaining deferral windows.
Planning Checklist: Before You List the Property
If you own a property that had a cost segregation study and you are considering a sale, run through these items with your CPA before listing:
Frequently Asked Questions
What is the difference between Section 1245 and Section 1250 depreciation recapture?
Section 1245 recapture applies to tangible personal property (5-year and 7-year assets identified in cost segregation) and is taxed at ordinary income rates up to 37% federal. Section 1250 applies to depreciable real property, including 15-year land improvements and the 27.5-year residential or 39-year commercial building: under IRC Section 1250(a), only accelerated depreciation in excess of straight-line on 15-year land improvements is recaptured at ordinary rates, while the straight-line portion of 15-year land improvements and straight-line building depreciation are taxed as Unrecaptured Section 1250 gain at a maximum 25% federal rate.
Does cost segregation increase depreciation recapture when you sell?
Yes. Cost segregation reclassifies building components into 5-year and 7-year personal property (subject to full Section 1245 recapture at ordinary income rates up to 37%) and 15-year Section 1250 land improvements (where accelerated depreciation in excess of straight-line is recaptured at ordinary rates under Section 1250(a), and the straight-line portion remains at the 25% Unrecaptured Section 1250 cap). However, the time value of money from accelerated deductions in the early years typically outweighs the higher recapture rate at sale, especially with holding periods of 5 or more years.
How does a 1031 exchange affect depreciation recapture?
Under post-TCJA IRC Section 1031(a)(1), like-kind exchanges apply strictly to real property. A properly structured 1031 exchange defers capital gains and Section 1245/1250 recapture to the extent relinquished real property is exchanged for qualifying like-kind replacement real property with sufficient replacement Section 1245/1250 real property and no taxable boot. However, under IRC Section 1245(b)(4), if non-like-kind Section 1245 personal property is transferred without qualifying replacement Section 1245 real property, ordinary recapture can be triggered in the year of the exchange.
Is depreciation recapture eliminated at death?
Yes. Under IRC Section 1014, heirs receive a stepped-up basis equal to fair market value at the date of death. This eliminates all accumulated depreciation recapture, including both Section 1245 and Section 1250 recapture. The depreciation taken during the owner's lifetime effectively becomes a permanent tax benefit. This is why many investors pursue a "buy, depreciate, exchange, die" strategy.
Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or financial advice. Depreciation recapture calculations depend on individual circumstances including filing status, state of residence, holding period, and overall income. Consult a qualified CPA or tax attorney before making decisions based on projected recapture amounts. Tax rates and thresholds referenced are based on 2026 tax law and may change.
Related: For a strategic framework on when cost segregation still wins after accounting for recapture at exit, see Overline's exit strategy recapture analysis.