Depreciation Recapture: The Tax Nobody Warned You About

• §1245 recapture — equipment, fixtures, and anything a cost segregation study carved out. Taxed as ordinary income, at your top rate, in the year of sale. It cannot be spread by an installment sale.
• Unrecaptured §1250 gain — the building itself. Taxed at a 25% ceiling, not a flat 25%. It can be spread by an installment sale — but it reports first, ahead of your lower-taxed capital gain.

Most articles collapse these into one paragraph called "25% recapture." That is wrong, and the error runs in the seller's disfavor on one side and the advisor's on the other.

Why you owe it at all

Every year you owned the property, depreciation reduced your taxable income. A $1,000,000 building on a 39-year commercial life produced roughly $25,600 of deduction annually. Over 25 years that is about $640,000 of income you never paid tax on.

Your basis went down by the same amount. So when you sell, the gain is larger by exactly what you deducted. Recapture is the government collecting on the deferral it granted you a year at a time.

The trap in §1016(a)(2): basis is reduced by depreciation allowed or allowable. If you owned a rental and never depreciated it, you still reduce basis as though you had. Not taking the deduction does not protect you from the recapture. It only means you paid full tax twice.

The three layers of a real estate gain

Every sale of depreciated real property splits into three pieces that are taxed differently and, in an installment sale, arrive in a specific order.

Two consequences follow immediately, and neither is obvious.

First: a cost segregation study creates a bill at closing. Cost seg firms sell the front end — accelerating deductions into years 1 through 5. Almost none of them explain the exit. Those accelerated dollars sat in §1245 property, and §453(i) forces every one of them into the year of sale as ordinary income, even if the rest of the deal is structured. If you did a cost seg, size that number before you sign a purchase agreement, because it must be paid in cash the year you close.

Second: the early years of an installment sale are the expensive ones. Because unrecaptured §1250 reports before capital gain, a seller spreading a sale over ten years does not pay one-tenth of a blended rate each year. They pay the 25% layer down first. That changes the optimal term, and any illustration that shows a flat annual tax is not modeling the code.

"25%" is a ceiling, not a rate

This is where most calculators quietly get it wrong. Under §1(h)(1)(E), unrecaptured §1250 gain is taxed at a maximum of 25%. The slice stacks on top of your ordinary income and fills the ordinary brackets — 22%, 24% — and stops at 25%.

A retired seller with $60,000 of other income does not pay 25% on the whole §1250 layer. Part of it fills the 22% and 24% brackets first. A seller with $600,000 of W-2 income does pay the full 25%, because they are already above the ceiling.

Which means the identical building generates a different recapture bill for two different owners. Anyone who quotes you a flat 25% has not asked about your income — and your income is the second-largest variable in the calculation.

The number most people get wrong: land

Land does not depreciate. Only the improvement does. So the size of your recapture depends entirely on how the original purchase price was split between land and building — and most online calculators default to something like 20% land.

In California that default is badly wrong. Real county assessor splits from three properties in 2026:

At a 20% land assumption you depreciate 80% of basis. At the true 47.5% you depreciate 52.5% — a 52% overstatement of accumulated depreciation, and therefore of the recapture bill.

Your county assessor publishes this split for free. It is on the parcel detail page, and under Proposition 13 in California it tracks the last purchase closely enough to be a defensible starting point. Use the real number before you use anyone's calculator, including ours.

Can you avoid depreciation recapture?

Honestly: rarely, and never by ignoring it. The realistic options:

1031 exchange. A properly completed like-kind exchange defers the whole gain, recapture included. If you are buying another property, this usually beats everything else — and if you hold until death, the basis steps up and the recapture disappears entirely. If you intend to keep owning real estate, stop reading here and call a qualified intermediary.

Installment sale under §453. Spreads the §1250 layer and the capital gain across the years you actually receive payments. Does not help §1245 recapture, which §453(i) pulls into year one regardless. Best for a seller who is done owning property and whose income drops after the sale.

Hold until death. Heirs receive a stepped-up basis under §1014 and the recapture is erased. This is why "never sell" is genuinely good tax advice for some owners, and why an installment note is a poor substitute — an installment obligation is income in respect of a decedent under §691 and gets no step-up. Your heirs inherit the tax bill.

Primary residence conversion. §121 can exclude $250,000 (single) or $500,000 (married) of gain — but §121(d)(6) specifically denies the exclusion for gain attributable to depreciation taken after May 6, 1997. Recapture survives §121. The exclusion shelters appreciation, never depreciation.

Opportunity zone, charitable remainder trust, structured sale. Each defers or splits the gain differently and each has a cost. None of them make §1245 recapture disappear.

What does not work: not claiming depreciation, holding a property in an LLC, or selling to a related party. The first is punished by §1016(a)(2), the second changes nothing, and the third is denied outright by §453(g) when the buyer is an entity you control — §453(e) separately accelerates your gain if a related buyer resells within two years.

A worked example

A commercial building bought in 2001 for $3,400,000, sold in 2026 for $8,279,700, with a 45% land share and no cost segregation.

The recapture layer is $1.2 million of the gain — over a fifth of it — and at a 25% ceiling that is roughly $300,000 of tax that has nothing to do with appreciation. It is the deductions coming home.

Change the land share to 20% and the depreciation figure becomes $1,743,590. Change the property life from 39 years to 27.5 as well, because someone checked "residential" by mistake, and it becomes $2,472,727. Two default settings compounding, a $1.27 million swing in the recapture layer. This is why the inputs matter more than the calculator.

Run your own numbers

The calculator at goldsteinco.net/demo splits any sale into all three layers, lets you set the real land share, and shows what changes if the gain is taken over one year, three years, or twenty. It is the same engine that produced the table above.

Frequently asked

Q: What is depreciation recapture in simple terms? A: It is tax on the depreciation deductions you already claimed. When you sell, the portion of your gain equal to accumulated depreciation is taxed before any capital-gains rate applies — as ordinary income for §1245 property, and at a 25% ceiling for the building under §1250.

Q: Is depreciation recapture always 25%? A: No. 25% is a maximum, not a flat rate. Unrecaptured §1250 gain stacks on your ordinary income and fills the ordinary brackets until it reaches the 25% ceiling, so a seller with low other income pays less. §1245 recapture is different again — it is ordinary income at your top marginal rate, with no ceiling.

Q: Can an installment sale spread depreciation recapture? A: Partly. Unrecaptured §1250 gain does spread across the payment years, but Reg. §1.453-12 requires it to be reported first, ahead of your capital gain. §1245 recapture does not spread at all — §453(i) recognizes it in full in the year of sale, so cash must be available at closing to pay it.

Q: What happens if I never took depreciation on my rental? A: You are still taxed on it. §1016(a)(2) reduces basis by depreciation "allowed or allowable," so skipping the deduction does not avoid the recapture — it just means you lost the deduction and still owe the tax. A CPA can often correct missed depreciation with Form 3115.

Q: Does the Section 121 home sale exclusion cover recapture? A: No. §121(d)(6) denies the exclusion for gain attributable to depreciation taken after May 6, 1997. If you rented the property, that depreciation is taxable even though the rest of your gain may be excluded.

Q: Does a cost segregation study increase recapture? A: It changes its character, which is worse. Cost seg moves basis into §1245 property with short lives. Those deductions come back as ordinary income rather than 25%-capped §1250 gain, and §453(i) forces all of it into the year of sale even in an installment sale.

Q: How do I find the land share of my purchase price? A: Your county assessor publishes the land and improvement split on the parcel record, free. Use the ratio from the year you bought, applied to what you actually paid. An appraisal at purchase is better evidence if you have one.

Q: Does a 1031 exchange eliminate recapture? A: It defers it. The recapture carries into the replacement property's basis. If you keep exchanging and hold until death, §1014 steps up the basis for your heirs and the deferred recapture is never paid.

Related

• Depreciation recapture tax rate — the rate table on its own
• Depreciation recapture calculator — run your own numbers
• Depreciation recapture in an installment sale — what §453 can and cannot spread
• Unrecaptured Section 1250 gain — the 25% bucket in detail
• Cost segregation and depreciation recapture — why a cost seg study raises the exit bill
• Structured installment sale — spreading what is left after recapture
• Form 6252 — the installment-sale return, line by line, with a worked example
• Capital gains calculator — all four tax layers, not just the capital gains rate