Cost Segregation and Depreciation Recapture

Depreciation recapture is an often misunderstood aspect of tax planning and comes into effect only during the sale of a property. Recapture is limited to the lesser of the gain or the depreciation taken. Meaning, first you have to sell the property and have a gain on the sale to even be concerned. To have a loss, one would have to sell the property for less than its net tax value. For practical purposes, the depreciation taken is the main limiting factor because the IRS calculates gain as the selling price less the net tax value (cost less depreciation taken). The recapture rules dictate how the gain is taxed, with § 1245 governing personal property and § 1250 governing real property. Section 1245 dictates that the accelerated depreciation taken on personal and real property be taxed at ordinary income tax rates. Section 1250 requires that depreciation taken on real property be taxed at a 25% capital gains rate. Any gain in excess of the total depreciation is taxed at the normal capital gains rate, but this does not wholly dictate whether recapture eliminates a need to do a cost segregation study. This is illustrated in the example below. Assuming your client has sold or is going to sell their building, let us use the facts below to show the benefit of a cost segregation study.

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