You took the depreciation deductions every year because they were free money on paper. The IRS remembers. Here's exactly how recapture works, why it's the one part of your gain that can't be softened by spreading, and what still helps.
Every year you own a rental, the IRS lets you deduct a portion of the building's value against your rental income — that's depreciation, and it lowers your tax bill year after year. But when you sell, the IRS wants some of that benefit back. The amount you depreciated over the years gets "recaptured" and taxed separately from the rest of your gain, under §1250 of the tax code, at a flat 25% federal rate — regardless of your income bracket.
This catches people off guard because it feels like it should just be part of the regular capital gains number. It isn't. It's calculated and taxed on its own, and it's recognized first, before the remaining appreciation gain.
Say you bought a rental for $500,000 and took $150,000 in depreciation deductions over the years you owned it, bringing your adjusted basis down to $350,000. You sell it for $900,000. Your total gain is $550,000 — but it splits into two very different tax buckets:
Add California tax on top of the recapture too — California doesn't have a separate recapture rate, it taxes that portion as ordinary income at up to 13.3%, on top of the federal 25%. On $150,000 of recapture alone, combined federal and CA exposure can approach $56,000-$57,000 before you even get to the rest of the gain.
This is the honest, unglamorous part. Even when you use an IRC §453 installment sale (via a Structured Installment Sale) to spread the appreciation portion of your gain across years, the depreciation recapture is generally recognized in the year of sale, not spread out — because it represents deductions you already took, not deferred appreciation. Some structuring approaches can affect the timing details, but the core rule stands: recapture is the one piece of a rental sale that resists the bracket-spreading benefit that helps everything else.
Anyone pitching you a strategy that claims to spread 100% of your gain — recapture included — without addressing this distinction isn't giving you the full picture.
It's worth saying plainly: this isn't a flaw in the Structured Installment Sale specifically. It's a feature of how §1250 recapture works under the tax code generally, whether you take the sale proceeds in one lump sum, carry a seller-financed note, or use an SIS. No legitimate strategy makes recapture disappear or spread — the honest goal is to know the exact number ahead of time and plan the rest of the sale around it.
The appreciation portion of your gain — often the larger piece on a long-held property — is exactly where a Structured Installment Sale does its work. In the example above, that's the $400,000 in appreciation gain. Sold in one lump sum alongside the recapture, a meaningful slice of that $400,000 can land in the higher federal brackets and trigger NIIT. Spread over 10-15 years of payments instead, illustratively more of it lands in the 0%/15% brackets, meaningfully lowering the blended effective rate on that portion. The recapture bill stays fixed either way — but the much larger appreciation gain next to it doesn't have to get taxed at the worst possible rate.
Before structuring any sale, the recapture amount needs to be calculated precisely — it depends on your original basis, every year of depreciation actually claimed (including any "cost segregation" acceleration), and improvements made along the way. Get this number wrong and the entire projection for the rest of the sale is wrong too. This is also why the structure needs to be arranged before escrow opens or the purchase agreement is signed — recapture math doesn't change that rule.
In practice, this means pulling your depreciation schedule from every tax return since you started renting the property, not just estimating from the purchase price. Landlords who used cost segregation studies to accelerate depreciation early on often have a larger, more front-loaded recapture number than they expect — worth confirming with your CPA before any sale numbers get modeled, since this office does not provide tax or legal advice.
Generally, no — recapture is recognized in the year of sale under standard installment sale rules, separate from the appreciation gain, which can be spread. This is a firm limitation, not a detail to gloss over.
A flat 25% federal rate under §1250, plus California taxing that portion as ordinary income at up to 13.3%, since California has no separate capital gains or recapture rate.
It's based on the depreciation you actually claimed (or were entitled to claim) over your ownership period, which lowers your adjusted basis and increases the taxable gain, split between recapture and regular appreciation.
Usually yes, because the appreciation portion of the gain — often the larger share on a long-held property — is exactly where spreading reduces the effective tax rate. Recapture stays fixed, but the rest of the gain doesn't have to be taxed at the worst rate.
A 1031 exchange can defer recapture along with the rest of the gain, but only if you reinvest in another qualifying property. If you want to walk away from real estate with cash in hand, recapture becomes due regardless of structure.
Plug in your sale price, basis, and state — the calculator runs your exact 2026 federal + California tax and shows what a Structured Installment Sale keeps in your pocket.
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Or talk it through: 213-340-2018 · Hans Goldstein · NPN 20602398. Educational only — not tax, legal, or accounting advice.
