Two depreciation lives, two recapture pools
A mixed-use building — say, ground-floor retail with upper-floor apartments — carries two depreciation schedules: the residential portion over 27.5 years and the commercial portion over 39 years. When you sell, the recapture calculation must be performed separately for each portion. The recapture rate is the same for both (up to 25% for Section 1250 real property), but the accumulated depreciation pool will differ because the commercial portion depreciates more slowly.
Example: a $1,200,000 building allocated 60% residential ($720,000) and 40% commercial ($480,000). After 10 years: residential depreciation = $720,000 ÷ 27.5 × 10 = $261,818; commercial depreciation = $480,000 ÷ 39 × 10 = $123,077. Total recapture exposure = $384,895 — all taxed at up to 25% regardless of which portion it came from.
Cost segregation makes allocation more complex
If you completed a cost segregation study on the mixed-use building, you also have 5-year and 15-year components allocated between the residential and commercial portions. The 5-year and 7-year personal property components create Section 1245 recapture — taxed at ordinary income rates, not the 25% cap. You need the cost seg engineer's report to separate which accelerated components are residential-portion and which are commercial-portion, because the allocation affects both your depreciation schedule and the character of recapture at sale.
Keep the cost seg report and the allocation workpapers permanently with your tax records.
Reporting at sale
At sale, report the total gain on Schedule D (for long-term capital gains) and any Section 1250 unrecaptured gain separately (the 25% rate applies on the collectibles worksheet in the tax instructions, effectively). Use Form 4797 to report depreciation recapture from the sale. Your tax professional will need: (1) the original allocated basis for each portion, (2) the annual depreciation claimed on each portion, and (3) the sale price allocation between residential and commercial.
Frequently asked questions
Do I need to track residential and commercial depreciation separately on a mixed-use building?
Yes. Each portion has a different recovery period (27.5 vs. 39 years), and at sale you must compute recapture on each pool independently. Commingling the depreciation creates errors in the gain calculation.
Is the recapture rate different for residential vs. commercial portions?
No. Both are Section 1250 property, so recapture on both is taxed at up to 25%. The difference is only in the annual depreciation amount — the commercial portion depreciates more slowly.
How do I allocate the sale price between residential and commercial portions?
Use the same method you used to allocate the original purchase price — typically square footage. A formal appraisal allocating the sale price is ideal for a large property.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.