Pay the Depreciation Recapture Now or Defer It: When Paying Wins

Recapture is not one tax but two, and only one of them has a 25% ceiling

Straight-line depreciation on a building becomes unrecaptured section 1250 gain when you sell. Section 1(h)(1)(E) taxes it at your ordinary rates but never above 25%. Depreciation on section 1245 property, such as appliances, carpet and the components a cost segregation study moves into short lives, is recaptured as ordinary income under section 1245 with no cap.

Publication 544 adds a third piece: any depreciation on section 1250 property above straight line is additional depreciation taxed as ordinary income. For most rentals depreciated on the standard schedule, only the capped layer exists.

This matters because the cap makes recapture cheapest for owners in the middle brackets and no more expensive than 25% for those at the top, while uncapped section 1245 recapture can cost up to 37%. Exchanging into real property defers all of it as long as no boot is received; whether a 1031 defers depreciation recapture covers the mechanics.

Worked model: the same $150,000 of recapture costs 17.3% for one couple and 25% for another

Hypothetical round numbers. A couple filing jointly sells a rental bought for $400,000 for $500,000 net, after $150,000 of straight-line depreciation. Adjusted basis is $250,000, so the gain is $250,000: $150,000 of unrecaptured section 1250 gain and $100,000 of other long-term gain. Brackets are from Rev. Proc. 2025-32; state tax is excluded. Run your own numbers with your CPA.

• Retired couple, $30,000 of other taxable income: the recapture fills $70,800 at 12% and $79,200 at 22%, so $25,920. The $100,000 above it is taxed at 15%, $15,000, and net investment income tax on $62,200 over the threshold adds $2,364. Total $43,284, or 17.3% of the gain.
• High-income couple, $400,000 of other taxable income: $3,550 of the recapture lands at 24% and the remaining $146,450 hits the 25% ceiling, so $37,465. The capital gain is $9,555 at 15% and $7,260 at 20%, and the 3.8% tax on the full $250,000 adds $9,500. Total $63,780, or 25.5%.
• The retired couple's recapture costs 17.3% of the layer; the high-income couple's costs 25%. Paying is far more attractive in the first case.

Four situations where paying the recapture now wins

Each of these turns on the gap between the rate you would pay today and the rate you expect to pay when the deferred gain finally comes due.

• A low-income year: retirement before required distributions, a sabbatical or a year of business losses can leave the 10%, 12% and 22% brackets empty. The 0% capital gain band ends at $98,900 of taxable income for joint filers in 2026, but recapture never qualifies for 0%; it simply takes the ordinary rate.
• A short horizon: if you will sell the replacement for cash within a few years, deferral buys little, and the replacement's own depreciation adds new recapture on top of the old.
• A fresh basis is worth more than the tax: a taxable sale lets you buy the next property with a full cost basis, depreciated at your marginal rate. Depreciation deducted at 32% or 35% and recaptured at no more than 25% is a rate gain, and section 168(k) as amended in 2025 allows 100% bonus depreciation on qualifying components acquired after January 19, 2025.
• Rate risk: the 25% ceiling and the brackets are set by statute and can change. Owners who expect higher rates or a move to a higher-tax state sometimes prefer to pay at today's known rates.

Three situations where deferring wins, and the one that usually decides it

Holding until death is the strongest case for deferral. Section 1014(a)(1) gives heirs a basis equal to fair market value at death, so recapture deferred through a chain of exchanges is never taxed. If that is the plan, paying now is a voluntary tax; see 1031 vs holding for step-up.

A high bracket today is the second: once your ordinary rate reaches 32%, every recapture dollar costs the full 25%, and you lose nothing by waiting for a lower-income year. The third is cost-segregated property, where section 1245 recapture can reach 37%. In an exchange, section 1245(b)(4) limits that recapture to the gain recognized plus the value of any property received that is not section 1245 property, so the replacement's own component mix matters; have your CPA run it before you identify.

Installment sales do not help with recapture. Section 453(i) recognizes recapture income in the year of the sale even if payments arrive later, so a seller-financed sale front-loads the very layer you might want to spread.

Partial exchanges let you pay some recapture in a cheap bracket and defer the rest

You do not have to choose all or nothing. Buying a smaller replacement or taking some cash creates boot that is taxed now while the rest stays deferred under section 1031(b). Sizing the boot to fill your 12% or 22% bracket is the usual target.

Which layer the boot is taxed as is a separate question, answered on whether boot is taxed as recapture or capital gain first; the planning around deliberate boot is on intentional boot strategies.

For owners comparing the whole sale with a full exchange in a low bracket, low-bracket tax vs a 1031 runs that decision.