Is depreciation recapture triggered by a condemnation of my rental under section 1033?

The recapture sections override everything except their own involuntary-conversion carve-outs

Section 1245(a)(1) and section 1250(a)(1) each say the ordinary income they create is recognized "notwithstanding any other provision of this subtitle", which is why recapture survives most nonrecognition rules. Section 1033 is one of two exceptions written into the recapture sections themselves, alongside section 1031.

Section 1245(b)(4) applies where "gain (determined without regard to this section) is not recognized in whole or in part under section 1031 or 1033". The ordinary income cannot exceed the gain recognized on the disposition plus the fair market value of acquired property that is not section 1245 property. Section 1250(d)(4) has the same structure for buildings: the amount taken into account cannot exceed the greater of the gain recognized, increased for certain stock acquisitions, or the recapture that would otherwise apply less the fair market value, or in a section 1033(a)(2) purchase the cost, of the section 1250 property acquired.

For a modern rental building the result is simpler than the drafting. Post-1986 real property is depreciated straight-line, so there is usually no section 1250 "additional depreciation"; what remains is unrecaptured section 1250 gain at up to 25%, taxed only on gain actually recognized. Whether a 1031 exchange defers depreciation recapture reaches the same place on the exchange side.

Keep part of the award and the recognized gain is recapture before it is anything else

Hypothetically, a condemned apartment building has an adjusted basis of $300,000 after $200,000 of straight-line depreciation, and the net award is $900,000, a $600,000 gain. You buy a $800,000 replacement building. Under section 1033(a)(2)(A) the $100,000 of award you did not reinvest is recognized gain. Because $200,000 of the gain is attributable to depreciation, the whole $100,000 recognized is unrecaptured section 1250 gain, taxed at up to 25% rather than at the 15% or 20% long-term rate. Run the split with your CPA, since your state may tax it differently.

Had the building been depreciated under an accelerated method with additional depreciation, section 1250(d)(4) would make the recognized $100,000 ordinary income to the extent of that additional depreciation, and Form 4797 Part III is where the figure is computed. The 2026 recapture rate and the unrecaptured section 1250 gain glossary entry cover the rates.

The rest of the depreciation history does not vanish. Section 1250(d)(4)(E) provides that for a section 1033 transaction the additional depreciation on the property acquired includes the amount not taken into account because of the cap, and section 1250(d)(4)(D) applies the section 1033(b)(2) basis reduction first to section 1250 property acquired. The replacement building starts with a low basis and the old recapture attributes attached to it.

The trap: cost-segregated components replaced with a building

Owners who ran a cost segregation study hold section 1245 property inside the building: carpets, fixtures, site improvements and similar components depreciated over 5, 7 or 15 years. When those components are condemned with the building, section 1245(b)(4) caps the recapture at the gain recognized plus the fair market value of acquired property "which is not section 1245 property".

That second term is the problem. If the replacement is an ordinary building bought without a new cost segregation, most of its value is section 1250 property, which is "not section 1245 property", and that value is added to the cap. Publication 544 illustrates the mechanics for personal property and notes a case where the amount recaptured "is greater than the gain otherwise recognized on the exchange". A full reinvestment can still produce section 1245 ordinary income if what you buy contains too little section 1245 property to absorb what you gave up.

The fix is in the purchase, not the election: have the replacement studied so its section 1245 components are identified and valued before closing. Section 1245 recapture on real estate explains which components are involved; your CPA should model the allocation on both sides.

• Section 1250 building replaced with a building of at least equal cost: no recapture recognized.
• Section 1245 components replaced with section 1245 components of equal or greater value: no recapture recognized.
• Section 1245 components replaced only with building and land: recapture up to the value of the non-1245 property acquired, even with full reinvestment.

Installment awards and the year-of-disposition rule

If you do not elect section 1033 and the award is paid over several years, section 453(i) requires recapture income to be recognized in the year of disposition whatever the payment schedule, so the ordinary income arrives before most of the cash does. A condemnation award paid in installments covers the timing on the deferral side, where nothing is recognized until you fall short of full reinvestment.

A shortfall recognized later goes on an amended return for the gain year, as electing section 1033 on an amended return explains, and its recapture character is fixed by that year's figures.

What the replacement's basis means for a DST interest

Any replacement bought under section 1033(a)(2) takes a basis equal to its cost less the deferred gain, with the reduction applied first to section 1250 property. A $800,000 replacement sheltering $500,000 of deferred gain starts with a $300,000 basis and correspondingly small depreciation, the same arithmetic that applies in an exchange, which depreciation inside a DST sets out for trust interests.

Whether a DST beneficial interest can be the replacement property under section 1033 at all is a question with no published answer, and a trust interest is illiquid with equity that can be lost. DSTs for 1033 proceeds describes the gap; take the recapture and the qualification question to your tax counsel together, because the section 1250(d)(4) ordering only matters if the purchase qualifies in the first place.