Depreciation Recapture on Rental Property, Explained

Depreciation recapture is the IRS's payback mechanism for depreciation deductions. Every dollar of depreciation you claimed lowered your property's cost basis, so when you sell, the IRS recharacterizes that portion of your gain and taxes it at higher rates — up to ordinary income rates for cost-segregated components, or a maximum of 25% for the building itself. If you used a cost segregation study to accelerate deductions, recapture is the trade-off you need to understand.

How Depreciation Recapture Works

Depreciation isn't free money — it's a timing shift. When you claim depreciation, you reduce your property's adjusted basis (your cost basis minus all depreciation taken). When you sell, your taxable gain is the sale price minus that reduced basis. The IRS treats the part of the gain that comes from prior depreciation differently from pure appreciation.

The mechanics are simple:

Adjusted basis = original purchase price − total depreciation taken

Realized gain = sale price − adjusted basis − selling costs

Recapture = the lesser of total depreciation taken and realized gain

That third line matters: you can only recapture up to the amount of gain. If you sell at a loss — or if the depreciation exceeds the gain — there is no recapture on the excess. There's also no escaping the "allowed or allowable" rule: the IRS recaptures depreciation you were entitled to take even if you never claimed it. Failing to depreciate doesn't avoid recapture; it just means you paid extra tax in the years you owned the property.

Section 1245 vs Section 1250: The Two Recapture Buckets

The IRS splits depreciable property into two buckets, and each has its own recapture rate. Which bucket your deductions fall into determines the tax bill on exit.

For rental property placed in service after 1986, the building is always depreciated straight-line, so "additional depreciation" is virtually zero — the building's depreciation portion of your gain simply caps at 25% federal. The cost-segregated short-life components, though, are Section 1245: every dollar of depreciation you took on them comes back as ordinary income when you sell.

This is the trade-off most investors miss: a cost segregation study front-loads deductions at ordinary-income savings rates, but recapture also returns at ordinary-income rates. The strategy still wins because of the time value of money — deducting $100,000 today and paying $32,000 back five years later beats never deducting at all. But you should model the exit, not just the entry.

A Worked Example: Selling an $800K Rental After 5 Years

Let's walk through a realistic scenario. You bought a residential rental for $800,000 in 2025. The land was worth $160,000, so your depreciable building basis is $640,000. A look-back or new cost segregation study reclassified $150,000 to 5-year property and $30,000 to 15-year land improvements.

Because the property was acquired and placed in service after January 19, 2025, the 100% bonus depreciation restored by the OBBBA lets you deduct the entire $180,000 reclassified portion in year one. The remaining $460,000 of building depreciates straight-line over 27.5 years — about $16,727 per year.

After five years:

You sell the property for $900,000 with $45,000 in selling costs, for net proceeds of $855,000. Total adjusted basis (building $376,364 + land $160,000) is $536,364, so your realized gain is $318,636.

That gain splits into three tax layers:

Notice what happened: the $180,000 you deducted in year one — probably at a 32% or higher marginal rate — comes back at the same ordinary rate. The straight-line building depreciation caps at 25%. And only the genuine appreciation above your original cost gets the favorable 15% long-term capital gains rate. Higher earners may also owe the 3.8% net investment income tax on the capital-gain layers.

Why Recapture Surprises Investors

Two things catch people off guard. First, the permanent 100% bonus depreciation under OBBBA (IRS Notice 2026-11, issued January 2026) front-loads deductions — which means it also front-loads recapture. A property with a cost segregation study will show a much bigger §1245 layer on exit than the same property depreciated straight-line. That's not a reason to skip the study — the upfront tax savings still compound in your favor — but it's a reason to plan the exit before you claim the deductions.

Second, recapture is a function of depreciation taken, not of how the deal performed. If your property barely appreciated, recapture can be most of your tax bill on sale. Investors who run the ROI math on cost segregation for the hold years sometimes forget to extend the same math through disposition.

Can You Avoid or Defer Depreciation Recapture?

You can't avoid recapture if you sell outright at a gain — but you have legitimate options to defer or eliminate it:

• 1031 exchange. A like-kind exchange defers both capital gains and depreciation recapture. The recapture liability carries into the replacement property; it's postponed, not forgiven.
• Hold until death. Heirs generally receive a stepped-up basis to fair market value, which can eliminate the recapture liability entirely. This is a cornerstone of long-term hold estate planning.
• Sell at a loss or break-even. Recapture is capped at your gain, so a property sold below its adjusted basis triggers no recapture at all.

Any of these is a planning decision with real dollars attached — work through it with your CPA before listing a property, not after the closing documents are signed.

Key Takeaways

• Depreciation lowers your basis; on sale, the IRS taxes the depreciation portion of your gain at higher recapture rates.
• Cost-segregated components (§1245) recapture at ordinary income rates; straight-line building depreciation (§1250) is capped at 25% as unrecaptured gain.
• Recapture applies to depreciation allowed or allowable — you can't dodge it by skipping deductions.
• 100% bonus depreciation under OBBBA amplifies both the upfront benefit and the eventual recapture; model both.
• A 1031 exchange defers recapture, and a stepped-up basis at death can eliminate it.

Want the deduction without the guesswork? A ROOM42 cost segregation study identifies every short-life component in your property so you know exactly what you're deducting today — and what could recapture tomorrow. Get your IRS-compliant study at room42.io for $525/unit.