The two categories
All depreciable assets fall into one of two IRS categories. Section 1250 property is real property — the building structure, its structural components, and land improvements. Depreciation recapture on Section 1250 property is the more favorable kind: it's taxed at your ordinary rate but capped at a maximum of 25% (unrecaptured Section 1250 gain).
Section 1245 property is personal property and certain other assets — equipment, appliances, machinery, and many building components when reclassified by a cost segregation study. Recapture on Section 1245 property is less favorable: it's taxed as ordinary income at your marginal rate, which could be 32%, 35%, or 37% for higher earners.
What cost segregation does
A cost segregation study identifies building components that qualify as Section 1245 property even though they are physically attached to a building. Examples include specialty electrical for a particular tenant's use, process piping, certain flooring, cabinets, and other elements tied to a specific use rather than general occupancy.
By reclassifying these to 5- or 7-year property, they depreciate faster — but they also become Section 1245 property. That means when you sell, those components' depreciation recaptures at ordinary income rates rather than the 25% cap. For a high-income investor in the 37% bracket, this could mean recapturing an accelerated deduction at a higher rate than it was taken — a real cost if not planned for.
Planning around the recapture difference
The standard answer is the 1031 exchange: defer both the Section 1245 and Section 1250 recapture by rolling the property. Alternatively, if you plan to hold until death, the step-up in basis your heirs receive eliminates accumulated recapture for both asset types — making cost segregation + hold-until-death a powerful strategy for long-term real estate investors. If you plan to sell, model both recapture amounts before commissioning the study to ensure the accelerated deductions today outweigh the higher recapture cost at sale.
Frequently asked questions
What is the recapture rate on Section 1245 property from cost segregation?
Ordinary income rates — up to 37% for the highest bracket — not the 25% cap that applies to Section 1250 real property recapture.
How do I know which components are Section 1245 vs. 1250?
The cost segregation study report lists each component and its classification. Items reclassified to 5- or 7-year MACRS life are typically Section 1245; 15-year land improvements are Section 1250.
Does a 1031 exchange defer Section 1245 recapture?
Yes — a 1031 exchange defers all gain including Section 1245 recapture. The carried-over basis keeps the recapture potential alive in the replacement 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.