How depreciation recapture works when you sell a rental

When you sell a rental at a gain, the depreciation you took comes back as taxable income. Depreciation on 5-year property like appliances and furniture is taxed at ordinary rates. Depreciation on the building and on straight-line site work is taxed at no more than 25%. None of it applies if you sell at a loss, because recapture can never exceed your gain.

A cost segregation study gives you deductions early and has you repay part of them later, sometimes at a higher rate. Whether that trade pays off depends mostly on how long you hold the property.

How the gain is split

Your total gain is the sale price, net of selling costs, minus your adjusted basis. Adjusted basis is what you paid plus improvements, minus all depreciation allowed or allowable. The “allowable” part means depreciation you were entitled to and skipped still reduces your basis. The look-back guide explains how to claim it if you missed it.

The gain is then sorted into four layers, each taxed differently.

Layer	Property	Federal rate
Section 1245 recapture	5- and 7-year property (appliances, carpet, furniture)	Ordinary rates, up to 37%
Section 1250 recapture	Bonus or accelerated depreciation on 15-year land improvements, above straight line	Ordinary rates
Unrecaptured section 1250 gain	Straight-line depreciation on the building and 15-year property	Ordinary rate, capped at 25%
Capital gain	Everything above total depreciation	0%, 15% or 20%

The 25% figure is a ceiling, not a flat rate. If your ordinary rate is lower, that lower rate applies to the unrecaptured section 1250 layer.

The 15-year land improvements trip people up. Driveways, fences and landscaping are section 1250 property, not section 1245. If you took 100% bonus on them, the excess over what straight-line would have given you is ordinary income. The straight-line part is taxed like the building, at up to 25%.

Recapture is limited to gain. For section 1245 property, the ordinary income is the lesser of the depreciation taken or the gain on those specific assets. That gain depends on how much of the sale price is allocated to them. Seven-year-old carpet and appliances usually aren’t worth much, so the allocation is often well below the depreciation taken. The allocation has to be reasonable and supportable, and your CPA sets it.

The 3.8% net investment income tax

If your modified adjusted gross income is above the threshold for your filing status, the 3.8% net investment income tax applies to the gain on top of everything above. Owners who qualify as real estate professionals and meet certain participation tests can sometimes exclude rental gain from it. Ask your CPA.

A 7-year hold, with and without a study

Illustration. An owner buys a rental for $500,000 with $100,000 of land and places it in service in January 2026. They sell in December 2032 for $600,000 after selling costs. They’re in the 35% bracket throughout, pay 20% on long-term capital gain, and can use rental losses each year.

The study puts $88,000 on 5-year schedules and $32,000 on 15-year schedules, all with 100% bonus. The building keeps $280,000.

Building depreciation uses the mid-month convention: 11.5 months in the January start year, 5 full years, and 11.5 months in the December sale year. That’s 6.92 years in total.

Item	No study	With study
Building depreciation	$100,606	$70,424
5- and 15-year depreciation	$0	$120,000
Total depreciation	$100,606	$190,424
Adjusted basis at sale	$399,394	$309,576
Total gain	$200,606	$290,424

The study adds $89,818 of depreciation over the hold. At 35%, that saves $31,436 of tax. Most of it comes in year one. The study adds $115,818 in 2026, worth $40,536, and then lowers depreciation by about $4,400 a year after that.

Now the sale. In the study case, assume $20,000 of the sale price is allocated to the 5-year property. Straight-line on the 15-year property over the same period would have been $12,800, so $19,200 of its bonus is ordinary income.

Sale tax	No study	With study
Ordinary income	$0	$39,200 at 35% = $13,720
Unrecaptured section 1250 gain	$100,606 at 25% = $25,152	$83,224 at 25% = $20,806
Capital gain	$100,000 at 20% = $20,000	$168,000 at 20% = $33,600
Total tax at sale	$45,152	$68,126

The study costs $22,975 more at sale. Against $31,436 of savings during the hold, the owner is $8,462 ahead in raw dollars, or about $7,600 after an $895 study fee.

Raw dollars understate it. The $40,536 arrived in 2026 and the extra sale tax is paid seven years later. Discounting every year’s tax difference at 6%, the study is worth about $15,900 in today’s dollars, or about $15,000 after the fee.

Two caveats. If the whole $88,000 of 5-year depreciation were recaptured as ordinary income, the sale tax would be $10,200 higher. And if the 3.8% tax applies at sale, the study’s larger gain adds about $3,400 more. The example also ignores state tax.

When a short hold makes a study a bad idea

If you sell within a year or two, there’s little time value to capture. You deduct the 5-year property at 35%. At sale, much of it comes back at 35%, because nearly new furniture and appliances can support a larger share of the sale price. You’ve traded a deduction for an equal tax bill a year later and paid a fee for the privilege. Unless you plan to hold for several years or exchange into another property, skip the study.

1031 exchanges defer most of it

A like-kind exchange defers the gain on real property you swap for other real property. Since 2018, section 1031 covers only real property. Furniture and other personal property sold with a rental aren’t covered, so gain allocated to them is taxable in the year of the exchange, including section 1245 recapture.

Some items a study puts on a 5-year schedule may still count as real property for exchange purposes. How recapture works on those is a technical question for your CPA and exchange intermediary. Plan the allocation before closing, not after.

Death, gifts and suspended losses

If you hold the rental until death, your heirs get a basis equal to its value at your death. The recapture disappears along with the capital gain.

Gifts work the other way. The recipient takes your basis and your depreciation history, so the recapture moves to them.

Passive losses you couldn’t use during the hold aren’t wasted. When you sell your entire interest in the activity to an unrelated buyer in a fully taxable sale, the suspended losses are released. They can offset the recapture and other income that year. A 1031 exchange doesn’t release them.

Selling a former home under section 121

If you lived in the property for at least two of the five years before the sale, you may exclude up to $250,000 of gain, or $500,000 for a married couple filing jointly. The exclusion doesn’t cover depreciation taken after May 6, 1997. That part of the gain is taxed under the recapture rules above, even if the rest is excluded.

A second limit applies if the property was a rental before you moved in. Rental periods after 2008 that came before your residence period are nonqualified use, and they reduce the share of gain you can exclude. Renting the home after you move out, within the five-year window, doesn’t count against you this way.

What to do next

If you’re deciding whether a study makes sense for a property you’ll sell in a few years, run both the purchase and the expected sale through the rental property depreciation calculator. Short-term rental owners can read cost segregation for Airbnb and VRBO homes for the furnished-home numbers. If you want a property-specific answer, request a free proposal. We’ll tell you if your hold period doesn’t justify the fee. Prices are on the pricing page and more answers are in the FAQ.

This is general information, not tax advice. Your CPA should confirm how it applies to you.