Recapture planning before the sale

Every dollar a cost segregation study accelerates is a dollar the seller meets again at closing, and the two meetings are priced differently. Gain on the study's Section 1245 components — appliances, finishes, land improvements — is ordinary income up to the depreciation taken. Gain on the Section 1250 building shell is unrecaptured Section 1250 gain at a maximum 25%. Exit planning is the art of managing which bucket the sale price falls into, and when. The mechanics of the two regimes are covered in depreciation recapture explained; this brief is the planning layer.

Price allocation: the lever that sets the buckets

Section 1245 recapture applies only to gain on the Section 1245 assets themselves. Aged carpet, ten-year-old appliances, and a weathered parking lot are often worth far less at sale than their original cost — sometimes less than their remaining basis. A supportable sale-price allocation that assigns those components their depressed fair values, with the residual to building and land, shrinks the ordinary-income bucket legitimately. The tools are the study's asset detail plus, where the buyer cooperates, a consistent allocation on both parties' Forms 8594 or in the purchase agreement. Allocations invented at return time without support draw the predictable response described in the Cost Segregation Audit Techniques Guide; the seller's low personal-property values also cut against the buyer, who wants them high, which is exactly why a negotiated allocation carries weight.

Installment notes: §1245 recapture will not wait

Seller financing defers gain under Section 453 — except the part that matters most here. Section 453(i), in Title 26, requires all Section 1245 (and true §1250) recapture to be recognized in the year of disposition, cash received or not. A seller who took $1.5M of accelerated deductions and closes with a 10% down payment can owe ordinary tax on the full recapture immediately — a negative-cash year one. The 25% unrecaptured §1250 gain, by contrast, spreads over the note. Model the year-of-sale tax before agreeing to the down payment; the note terms, not the rate tables, are usually what makes an installment exit fail.

The 1031 alternative

A like-kind exchange defers the whole stack — capital gain, 25% gain, and §1245 recapture — so long as the replacement is real property and, post-TCJA, the components the study classified as personal property for depreciation still qualify as real property under the §1031 regulations (state-law fixtures generally do). Carryover basis means the recapture attributes travel with the taxpayer rather than disappearing. The interaction — including basis tracking across exchanges and the exchange-then-hold-until-death endgame — is treated in cost segregation and 1031 exchanges.

Holding, and the step-up at death

Under Section 1014, basis steps to fair market value at death and the recapture history evaporates. For an owner in their seventies holding a fully depreciated, cost-segregated asset, the after-tax ranking is often: hold (or exchange) until death, then heirs sell or restudy — no recapture, ever. Selling to redeploy capital must beat that benchmark, not merely produce a gain.

Comparing the exits

Illustrative federal tax in the year of sale — $5M sale, $1.2M total gain, of which $400,000 is §1245 recapture (37% ordinary rate) and $500,000 is unrecaptured §1250 gain (25%), remainder at 20%: