Depreciation Recapture Tax

The IRS calculates recapture based on depreciation allowed or allowable, meaning an owner who forgot to claim depreciation in some years, or never filed the right schedule, still owes recapture as if the deduction had been taken. A Danville landlord who skipped depreciation for three years out of a fifteen-year hold does not get a lower recapture bill for those skipped years; a tax preparer can sometimes correct missed depreciation through an accounting method change, but the recapture exposure exists either way.

At sale, total accumulated depreciation is separated out from the rest of the gain and taxed under its own rules, generally at a rate different from standard long-term capital gains rates and different from ordinary income rates. On a commercial building in Lynchburg sold after twenty years of ownership, the accumulated depreciation alone can represent a substantial share of the total tax bill, often larger than most sellers estimate before running the actual numbers with a tax preparer.

Owners who used cost segregation to accelerate depreciation on certain building components, such as flooring, fixtures, or site improvements, face recapture calculated separately on those faster-depreciating components as well. A Roanoke industrial owner who cost-segregated a portion of a building years ago and depreciated it on a shorter schedule has effectively pulled forward tax savings that now need to be accounted for at sale, sometimes at less favorable rates than the recapture on the building's standard depreciation.

A 1031 exchange defers depreciation recapture along with the rest of the gain, provided the sale qualifies as investment or business property and the exchange rules are followed correctly, including the 45-day identification window and 180-day closing deadline. The deferred recapture does not disappear; it carries forward into the replacement property's basis and becomes due again if that property is eventually sold in a fully taxable transaction rather than exchanged again. This is one reason long-term Virginia investors sometimes exchange repeatedly over decades rather than cashing out, deferring an ever-growing recapture liability each time.

Because recapture is calculated from an owner's full depreciation history rather than a simple percentage of the sale price, a rough estimate pulled together the week before listing is often wrong in either direction. A Virginia investor working with a CPA to pull the actual depreciation schedule, including any accelerated components from a past cost segregation study, gets a much more reliable number than one based on a general rule of thumb. That number then informs whether an exchange is worth pursuing, since a property with modest accumulated depreciation carries a smaller recapture exposure to defer than one held and depreciated for twenty-five years.