Understanding Depreciation Recapture: §1245 vs. §1250 Property

Most real estate investors hear about depreciation as a huge tax benefit. What doesn’t always get explained is what happens later…when you sell.

That's where depreciation recapture comes in: depreciation on the building is taxed at up to 25% at sale, and depreciation on shorter-life property identified in a cost segregation study is taxed at ordinary income rates. Which bucket each dollar lands in is set by two sections of the tax code, §1245 and §1250.

What Is the Difference Between §1245 and §1250 Property?

The terms “§1245” and “§1250” sound intimidating, but all they mean is different buckets in the tax code. The IRS likes to put assets into categories so they know how to treat them when you sell. Think of it like this:

1. §1250 property = your building itself

The walls, roof, foundation, and structural systems, plus components like HVAC and general plumbing and electrical. For a residential rental placed in service after 1986, depreciated straight-line, and held more than a year, the depreciation you claimed generally becomes unrecaptured §1250 gain when you sell, taxed at a maximum 25% rate, even if your ordinary rate is higher. Technically, that isn't ordinary-income recapture; true §1250 recapture applies only to depreciation above straight-line.

2. §1245 property = shorter-life personal property inside the building

These are the assets a cost segregation study pulls out of the building, often 5- or 7-year property depending on the asset and the industry. In a residential rental, that typically means appliances, carpet, and electrical dedicated to specific equipment. When you sell, the depreciation you claimed on them is taxed as ordinary income, at rates up to 37% as of 2026.

Here's the key: a cost segregation study moves value out of the building bucket and into shorter-life buckets. Those assets wear out faster than the building itself, which means you get to depreciate (write off) their cost faster.

Why Does the §1245 vs. §1250 Distinction Matter for Real Estate Investors?

Imagine you buy a $1M apartment building and $200,000 of the price is land. Without a cost segregation study, you depreciate the remaining $800,000 over 27.5 years, or about $29,000 a year. With a study, you might reclassify $250,000 as shorter-life property, and as of 2026, 100% bonus depreciation lets you deduct it in Year 1 if the property was acquired after January 19, 2025, and placed in service after January 19, 2025. For an investor who can use the deductions at a 37% rate, that's close to $100,000 in Year 1 tax savings.

When you sell, more of that comes back as recapture, and at a higher rate. But you controlled the timing: you got the savings up front, when you could put the cash to work. The case study below runs both sides of the math.

How Is Depreciation Recapture Calculated When You Sell?

Depreciation recapture is calculated asset by asset. For each asset, subtract its adjusted basis from the share of the sale price allocated to it. That gain, up to the depreciation you claimed, is recaptured: at ordinary income rates for §1245 property and at up to 25% for the building's straight-line depreciation. Any gain beyond that is long-term capital gain.

What Is the Formula for §1245 Recapture?

§1245 recapture = the lesser of:

1. Total depreciation allowed or allowable on the §1245 property, including bonus depreciation, Section 179, and any depreciation you were entitled to but didn't claim, or
2. The gain on that property: the portion of the sale price allocated to it, minus its adjusted basis.

That amount is taxed as ordinary income. For example, $250,000 of 5-year property fully deducted with bonus depreciation has an adjusted basis of zero. If $60,000 of the sale price is allocated to it, because five-year-old carpet and appliances are worth far less than they cost, the gain on it is $60,000, so §1245 recapture is $60,000, not $250,000. The rest of the sale price is allocated to the building and land, so that gain shifts into the lower-rate tiers rather than disappearing.

How Does the Gain Get Divided Across Asset Classes?

Total gain on a sale is split into tiers, each taxed differently:

1. §1245 recapture: ordinary income, at rates up to 37% as of 2026.
2. Ordinary §1250 recapture: on land improvements that received bonus or accelerated depreciation, the depreciation above straight-line.
3. Unrecaptured §1250 gain: the straight-line depreciation on the building and land improvements, taxed at up to 25%.
4. Long-term capital gain: everything left, taxed at 0%, 15%, or 20%.

Higher-income investors may also owe the 3.8% net investment income tax on top. How much lands in each tier depends on how the sale price is allocated among the assets, so that allocation should be supported by an appraisal and documented in the purchase agreement.

In the case study below, the $550,000 gain splits into $250,000 of §1245 recapture, $100,000 of unrecaptured §1250 gain, and $200,000 of capital gain, assuming all of the §1245 depreciation is recaptured.

5 Ways to Defer or Reduce Depreciation Recapture

So, the IRS isn’t giving you a free ride. They’re letting you take deductions early (on §1245 property), but they’ll want some of it back later if you sell. The trick (and this is why savvy investors use cost segregation) is that you can often defer, reduce, or offset that recapture: Here are the main strategies smart investors use:

1. 1031 Exchange

A 1031 exchange lets you defer gain, including recapture, by reinvesting in like-kind real property.

• Since 2018, §1031 applies only to real property.
• Any cash or other non-like-kind property you receive (boot) is taxable, and that gain is treated as recapture first.
• §1245 recapture can still be triggered if the replacement property has less §1245 property than the property you sold.
• The deferred tax comes due when you eventually sell without exchanging.
• Investors who keep exchanging and hold until death may never pay it.

2. Buy More Real Estate

Depreciation from a new property can help offset income from a sale, including recapture.

• The new property generally has to be placed in service in the same tax year as the sale.
• A cost segregation study on the new property increases the depreciation available that year.
• Whether the deductions can offset the gain depends on the passive activity, at-risk, and basis rules, and on your overall tax picture.

3. Installment Sale (for the Non-Recapture Portion)

Having the buyer pay you over time can spread part of the tax across several years.

• The installment method spreads the tax on unrecaptured §1250 gain and §1231 gain across the years you receive payments.
• It does not spread recapture. Under IRC § 453(i), all §1245 recapture, and any ordinary §1250 recapture, is taxed in the year of sale.
• That can create a Year 1 tax bill larger than the cash you collect that year, so plan for it up front.

4. Hold Longer

Even if you pay recapture later, the upfront savings have already been working for you.

• In the case study below, the extra ~$89,000 of Year 1 tax savings, invested at 7% for five years, grows to about $125,000 before tax.
• That's more than the ~$81,000 of additional tax owed at sale.
• That's the time value of money in action.

5. Hold Until Death

When the owner dies, the property passes to heirs with a fresh tax basis, and the prior owner's recapture exposure doesn't pass with it.

• Heirs generally take a new basis equal to the property's fair market value at the date of death, or the alternate valuation date if the estate elects it.
• The heir generally doesn't inherit recapture on the prior owner's depreciation.
• The heir can run a new cost segregation study on the new basis once the property is placed in service as a rental.
• Bonus depreciation isn't available on the inherited basis itself.
• Recapture applies only to depreciation the heir claims after inheriting.

Case Study: How Does Cost Segregation Change the Math on a $1M Property?

Let’s look at a simple example.

Assumptions:

• Purchase price: $1,000,000; land $200,000; depreciable basis $800,000
• Sale after 5 years for $1,200,000
• Investor in the 37% bracket, able to use the deductions (for example, with real estate professional status)
• With cost seg: $250,000 reclassified and deducted in Year 1 with 100% bonus depreciation (property acquired after January 19, 2025, and placed in service after January 19, 2025)
• Straight-line on the building, simplified (no mid-month convention); all depreciation recaptured; 20% capital gains rate; net investment income tax ignored

The Difference

• About $89,000 more in Year 1 tax savings.
• About $75,700 more in tax savings over five years, and about $81,100 more tax at sale.
• In this example, cost segregation costs about $5,500 more in total tax and puts roughly $89,000 in your hands four years earlier. The $200,000 of appreciation is taxed the same way either way.

Cost segregation isn’t about avoiding taxes forever. It’s about accelerating deductions into the years when you need the cash most and making smart moves so that recapture doesn’t catch you off guard later.