How depreciation recapture works (and why it matters at sale)

The shield

For each year you own an income-producing building, the IRS lets you deduct a portion of its cost — even though the building isn't actually losing value (in fact, it's usually appreciating). Residential rentals depreciate over 27.5 years straight-line; commercial over 39 years. Land doesn't depreciate.

For a $300k residential rental with $60k of land value, you can deduct $240k ÷ 27.5 = ~$8,727/yr against your rental income. If your marginal tax rate is 32%, that's ~$2,793/yr of tax savings. Multiply that by 10-20 years of ownership and the cumulative tax shield is real money.

Bonus depreciation and cost segregation can front-load even more of this — turning what would have been a $9k/yr deduction into a $60-150k year-one deduction.

The recapture

When you sell, the IRS wants their tax back on the depreciation you took. This is §1250 depreciation recapture, taxed at up to 25% (the "unrecaptured §1250 gain" rate).

Example: you owned a property for 10 years and took $90k of cumulative depreciation. When you sell, $90k of your gain is taxed at 25% (= $22,500 of federal tax), regardless of your basis or other tax considerations.

Why this surprises people

Two reasons:

You can't opt out. The IRS calculates recapture on the depreciation you were allowed to take, not the depreciation you actually claimed. So if you forgot to depreciate (a common bookkeeping mistake), you still owe recapture as if you had — but you don't get the savings retroactively.
It compounds with cap gain. Sale price minus adjusted basis = total gain. The depreciation portion gets the 25% recapture rate; the rest gets the long-term capital gains rate (0%, 15%, or 20%). On big appreciation events, the combined federal-only tax bill on sale can hit 25-28% of the gain.

The 1031 escape

The cleanest way to defer recapture is to roll into another investment property via a 1031 exchange. The deferred gain (including the recapture portion) carries over into your basis in the replacement, and the tax is owed only if/when you eventually cash out.

Alternative: hold until death. Heirs get a stepped-up basis to fair market value, wiping out both the recapture and the capital gain in one stroke. This is the literal "swap 'til you drop" strategy.

Cost segregation tradeoff

Cost seg accelerates depreciation, which is great for current cash flow. But every dollar of accelerated depreciation is a dollar of future recapture. The strategy works best when:

You're in a high marginal bracket today (high tax savings)
You plan to hold for 5+ years (time value of money)
You'll exit via 1031 (defer the recapture indefinitely)

Run your specific numbers in the Depreciation Calculator. The "recapture liability at sale" row is the eye-opener — that's the tax bill you're stacking up, not just the savings.