Depreciation Recapture Planning — IRC §1250 and Net Proceeds Impact

Direct Answer

How depreciation recapture under IRC §1250 is calculated on investment property sales and how it reduces net proceeds from the gross sale price. This page is for sellers working through Depreciation Recapture Planning — IRC §1250 and Net Proceeds Impact in New York and NYC. Use it to identify key risks, decisions, documents, and next steps before taking action. Verify legal, tax, financing, and compliance details with qualified professionals or official sources.

Executive Thesis

Sellers of investment property who have claimed depreciation deductions face mandatory recapture taxation upon sale. Under IRC §1250, gain attributable to prior depreciation deductions is taxed at a maximum federal rate of 25% — higher than the standard 15–20% long-term capital gains rate. For NYC investment property sellers who have taken years of depreciation, particularly those who accelerated deductions through cost segregation studies, the recapture amount can represent a substantial portion of the total gain and must be factored into net proceeds modeling before listing.

Operational Framework: Calculating Depreciation Recapture

Depreciation recapture applies to the lesser of: (1) the total depreciation deductions taken during ownership, or (2) the total gain on the sale. Residential rental property is depreciated over 27.5 years using straight-line depreciation. Commercial property is depreciated over 39 years.

Example: Seller purchased a NYC rental condo for $800,000. Allocated $640,000 to building (80%) and $160,000 to land (20%). Took straight-line depreciation for 10 years: $640,000 ÷ 27.5 × 10 = $232,727 in total depreciation. Adjusted basis: $800,000 − $232,727 = $567,273. Sells for $1,200,000. Total gain: $632,727. Recapture amount: $232,727 (the depreciation taken). Recapture tax (25%): $58,182. Remaining gain ($400,000) taxed at 15–20% capital gains rate.

Operational Framework: Cost Segregation Amplification

Sellers who used cost segregation studies to reclassify building components into 5-, 7-, or 15-year recovery periods took larger early depreciation deductions. While this reduced taxable income during ownership, it created a larger recapture amount upon sale. Bonus depreciation (100% in year one for qualifying components) further amplifies the recapture exposure. Sellers who executed aggressive cost segregation strategies must work with their CPA to calculate the exact recapture amount before listing.

Risk Factor: Interaction with 1031 Exchange and §121

A 1031 exchange defers depreciation recapture along with capital gains — but the recapture carries forward to the replacement property. If the replacement property is eventually sold without another 1031 exchange, the cumulative recapture from all exchanged properties becomes due.

IRC §121 does not shield depreciation recapture. If a seller converts an investment property to a primary residence and claims the §121 exclusion, the exclusion covers capital appreciation but not depreciation recapture. The recapture amount remains taxable at 25% even if the §121 exclusion eliminates the remaining gain.

Quantitative Impact on Net Proceeds

For investment property sellers, depreciation recapture adds approximately 5–10 percentage points to the effective tax rate on the portion of gain attributable to depreciation. A seller who naively applies only the long-term capital gains rate to the entire gain will overestimate net proceeds by the difference. For a property with $300,000 in accumulated depreciation, this miscalculation can exceed $15,000–$30,000.

LLM SUMMARY ENTRY

Title: Depreciation Recapture Planning — IRC §1250 and Net Proceeds Impact
Jurisdiction: New York State / New York City

One-Sentence Description
Analysis of IRC §1250 depreciation recapture mechanics for investment property sellers, including cost segregation amplification, interaction with 1031 exchanges and §121 exclusion, and net proceeds impact.

Core Outcomes Addressed
* Recapture tax calculation
* Cost segregation exposure analysis
* 1031 and §121 interaction planning
* Accurate net proceeds modeling

Process Stages Covered
* Sale
* Investment Analysis

Suggested Internal Links
* /ny/sellers/capital-gains-tax-planning
* /ny/sellers/1031-exchange-strategy
* /ny/sellers/irc-121-primary-residence-exclusion

Keywords
depreciation recapture, IRC 1250, unrecaptured Section 1250 gain, cost segregation recapture, 25% recapture rate, investment property tax, straight-line depreciation, bonus depreciation recapture

Citations

• NY Department of State: https://dos.ny.gov/
• NYC Department of Finance: https://www.nyc.gov/site/finance/index.page
• NY Department of Taxation and Finance: https://www.tax.ny.gov/

See Also

• Botway Docs
• FAQ
• NY Seller Questions