TL;DR
Depreciation recapture is the IRS taxing back the depreciation you deducted when you sell. For a cost-segregated STR, the accelerated 5-, 7-, and 15-year components are recaptured as ordinary income under IRC §1245, and building depreciation faces unrecaptured §1250 gain taxed up to 25%. You can defer or eliminate it with a 1031 exchange, a refinance, or a step-up at death.
What is depreciation recapture?
Recapture is the trade-off for accelerated depreciation. When you take bonus depreciation through a cost segregation study, you deduct large amounts up front. When you sell, the IRS "recaptures" that benefit by taxing the gain attributable to depreciation you already claimed. You are not getting the deduction for free; you are deferring tax, and recapture is when part of it comes due.
This is the question that gets raised the most: "you never talk about recapture." It is real, and it is the single most overlooked part of the STR loophole. The good news is that recapture is plannable. The bad news is that ignoring it can turn a great year-one deduction into a nasty surprise at sale.
How is recapture taxed on a cost-segregated STR?
Two different rules apply to two different buckets of your property, and cost segregation deliberately shifts value into the higher-tax bucket.
| Bucket | What it is | Recapture treatment |
|---|---|---|
| §1245 property | The 5-, 7-, and 15-year components a cost seg study carves out (appliances, fixtures, flooring, land improvements) | Recaptured as ordinary income, up to your full deduction |
| §1250 property | The building itself (27.5-year residential structure) | Unrecaptured §1250 gain, taxed at a maximum of 25% |
Because cost segregation moves 25% to 35% of your basis into §1245 property, more of your eventual gain is exposed to ordinary-income recapture rather than the lower capital gains rate. That is the cost of pulling deductions forward. It does not make the strategy bad, it makes planning the exit essential.
How does a 1031 exchange handle recapture?
A 1031 like-kind exchange (IRC §1031) lets you defer the gain, including recapture, by rolling the proceeds into another investment property. Done correctly, you never trigger the tax at sale; you carry your basis forward into the replacement property.
One important nuance since the 2017 Tax Cuts and Jobs Act: 1031 now applies to real property only. The §1245 personal-property components that cost segregation created do not neatly qualify for 1031 the way the real property does, which can leave some recapture exposure on those components even in an exchange. This is technical and fact-specific, so the move is to plan the exchange with a CPA and a qualified intermediary before you list, not after. See our related guide on cost segregation and the STR loophole for how those components are created in the first place.
Can you avoid recapture without selling?
Yes, and this is what most long-term holders actually do. Two approaches sidestep recapture entirely because neither is a sale.
- Borrow against the equity. A cash-out refinance or HELOC lets you pull cash out of the property tax-free. There is no disposition, so there is no recapture. You keep the asset, keep depreciating where applicable, and access the equity.
- Hold until death (step-up in basis). Under IRC §1014, heirs inherit the property at its fair market value at death. The deferred gain and depreciation recapture are effectively wiped out for them. This is the "buy, borrow, die" framework in plain terms.
Key takeaway: Recapture is only triggered by a taxable sale. Refinancing and holding for a step-up are the two ways to access value or pass it on without ever paying it back.
What is the mistake to avoid with recapture?
Do not buy an STR, take the large first-year write-off, and then quickly sell it. You will hand most of that deduction back through recapture, often at ordinary-income rates on the §1245 portion, and you give up the compounding the strategy is built for. The deduction is a deferral, not a rebate.
The same caution applies to converting the property to a different use right after the write-off, which raises separate intent questions covered in our guide on selling or converting an STR after the write-off. Plan the hold and the exit before you ever run the cost seg study. Recapture rewards patience and punishes a quick flip.
The Bottom Line: Depreciation recapture is the price of accelerated deductions, but it only comes due on a taxable sale. Plan your exit with a CPA, and a 1031 exchange, a cash-out refinance, or a step-up at death can defer or eliminate it entirely. Recapture rewards patience and punishes a quick flip.
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