Understanding Depreciation Recapture
Depreciation recapture applies when depreciated property is sold at a gain. The tax code requires that accelerated depreciation taken during ownership be recaptured as ordinary income or taxed at special rates upon sale. Retail property owners benefiting from cost segregation should understand this future obligation.
Personal property depreciation creates Section 1245 recapture taxed at ordinary income rates. For retail properties, components such as tenant improvements, fixtures, and specialty equipment classified as personal property generate 1245 recapture when the property sells at a gain.
Real property depreciation creates Section 1250 recapture taxed at a maximum 25% rate. Building and land improvement depreciation falls under 1250 recapture rules, which often result in lower tax rates than 1245 recapture on personal property.
The total recapture cannot exceed the gain on sale. If a property sells at a loss or minimal gain, recapture may be reduced or eliminated. However, properties that have appreciated typically generate sufficient gain to trigger full recapture of accelerated depreciation.
How Cost Segregation Affects Recapture
Cost segregation accelerates depreciation, increasing accumulated depreciation at any given point during ownership. Higher accumulated depreciation increases potential recapture upon sale. This is a timing benefit, not an elimination of tax—you pay less now and more later.
The character of recapture depends on component classification. Components classified as personal property during cost segregation will generate 1245 recapture at ordinary rates, while land improvements generate 1250 recapture at preferential rates. Understanding this distinction affects planning.
Bonus depreciation magnifies recapture effects. When 100% bonus depreciation applies to qualifying property, the entire cost is deducted in year one and recaptured upon sale. This creates maximum current benefit but also maximum future recapture exposure.
The time value of money typically favors accelerated depreciation despite recapture. Deductions taken immediately have more value than the same tax paid later. However, tax rate changes could affect this analysis if rates increase between deduction and sale.
Strategies for Managing Recapture
Like-kind exchanges under Section 1031 defer recapture along with other gain recognition. When retail property is exchanged for qualifying replacement property, accumulated depreciation transfers to the new property basis rather than triggering current recapture.
Installment sales spread gain and recapture over the payment period, potentially managing tax bracket exposure. However, depreciation recapture is generally recognized in the year of sale regardless of payment timing, limiting this strategy's effectiveness for recapture specifically.
Holding period affects the balance between current deductions and future recapture. Shorter holds maximize benefit from accelerated depreciation relative to recapture, while very long holds allow depreciation to approach straight-line regardless of acceleration.
Exit strategy planning should model recapture scenarios. Understanding potential recapture tax before sale enables comparison with alternative exit strategies including refinancing, continued hold, or like-kind exchange.
How Goodlane Group Helps with Recapture Planning
Goodlane Group helps retail property owners understand recapture implications before conducting cost segregation studies. Informed decisions about accelerated depreciation consider both current benefits and future recapture obligations.
We work with your tax advisors to model recapture scenarios based on anticipated exit timing and strategy. This analysis quantifies the net benefit of cost segregation considering the full ownership lifecycle.
Our preliminary cost segregation estimates include recapture projections showing how accelerated depreciation affects taxable gain upon sale. This information supports informed decisions about whether to maximize acceleration or moderate it based on your situation.
For owners considering property sales, Goodlane Group coordinates disposition planning including recapture analysis and alternative transaction structures. We help ensure you understand tax implications before committing to sale terms.