Depreciation Recapture After Cost Segregation
Plan for a property sale using asset-level basis, depreciation, and sale allocations. Recapture is not one flat rate applied to every component.
Why the sale needs an asset-level review
Cost segregation creates component records that remain relevant when assets are sold or removed. Give the sale adviser the final study, subsequent additions, prior dispositions, and current depreciation schedule. A single original purchase price does not describe the adjusted basis of every asset still present at sale.
Section 1245 is limited by the applicable gain calculation
For a typical taxable sale of section 1245 property, ordinary-income recapture is generally limited to the lesser of depreciation subject to recapture and recognized gain. It is inaccurate to say every depreciation dollar always returns as ordinary income regardless of the sale result. The preparer must determine the classification and calculation for the actual assets.
Section 1250 is not simply a flat 25% tax
Section 1250 can produce ordinary income from additional depreciation. Unrecaptured section 1250 gain is a related but different category, with a maximum 25% federal rate for individuals where applicable. A 15-year recovery period alone does not establish the entire sale treatment. Avoid assigning one rate to all land improvements or structural components without reviewing the facts.
Reconcile what is still there
Before sale, identify assets replaced since the study, items retained by the seller, and equipment included under a separate agreement. Retain invoices and disposition records. The proposed sale allocation should reflect the actual transaction and receive adviser review; it should not be reverse-engineered solely to minimize recapture.
Use a holding-period comparison
Ask the adviser to compare the timing benefit of earlier deductions with expected sale consequences, transaction costs, and uncertainty. A simplified model should state its assumptions and show more than one holding period. A planned exchange or investment structure needs its own eligibility review and does not automatically eliminate recapture on every component.
Records to send before closing
Provide the signed sale contract and allocation exhibits, original study, updated asset schedule, improvement invoices, removed-item list, and any proposed exchange documents. Resolve discrepancies while the parties can still clarify the contract. Waiting until return preparation can make it harder to recover the physical and transaction evidence.
Primary references
Educational information. The return preparer should verify current guidance and apply it to the taxpayer’s facts.