Depreciation recapture surprises more New York City property owners than any other line item in a sale, mainly because it is a bill for a benefit the owner already used. Every year a rental or commercial building is depreciated, the deduction lowers taxable rental income; at sale, that same depreciation gets added back and taxed, at a rate that does not match the long-term capital gains rate most owners expect to pay on the rest of the gain. Understanding how the calculation works, separately from the appreciation gain, changes how a sale actually gets priced out.
How Recapture Is Calculated
Recapture is based on the total depreciation claimed against the property over the years it was owned, whether taken through straight-line depreciation or accelerated through a cost segregation study. That accumulated amount is taxed federally at a rate capped at 25 percent for real property, separate from the standard long-term capital gains rate, which is usually lower, applied to the remaining appreciation gain above the depreciation already claimed.
Why It Applies Even to a Break-Even or Loss Sale
An owner can sell a property for barely more than they paid for it and still owe substantial recapture tax, because recapture is based on depreciation claimed, not on overall profitability. A Bronx multifamily building bought years ago and depreciated heavily can generate a large recapture bill at sale even if the sale price only modestly exceeds the original purchase price, since the depreciation deductions reduced basis far more than the price appreciated.
Cost Segregation's Effect on the Eventual Bill
Cost segregation studies reclassify parts of a building into shorter depreciation schedules, front-loading larger deductions in the early years of ownership, which reduces taxable income during the hold. The tradeoff shows up at sale: faster depreciation means a lower remaining basis and a larger recapture amount when the property is sold, so an owner who used cost segregation aggressively should expect the recapture line to be proportionally larger than an owner who depreciated the same property on a standard schedule.
Deferring Recapture Through an Exchange
A 1031 exchange defers depreciation recapture along with the rest of the gain when the sale proceeds move into a qualifying replacement property through a qualified intermediary and the identification and closing deadlines are met. The recapture liability does not disappear; it carries into the replacement property's basis and would be triggered again on a future sale that is not itself exchanged, which is why owners who plan to keep trading up in New York City real estate over time can defer recapture repeatedly across a series of exchanges.
Estimating Recapture Before Listing a Building
A depreciation schedule kept by the owner's accountant, or reconstructed from prior tax returns when records are incomplete, is the starting point for estimating recapture before a sale is even listed. Owners of an older Queens or Bronx multifamily building who have depreciated the structure for fifteen or twenty years should ask their accountant to run this number early, since a rough recapture estimate often changes whether an exchange is worth the coordination effort compared to simply paying the tax and keeping the proceeds. Waiting until the closing statement is drafted to find out the recapture figure leaves little time to structure a deferral.
Common 1031 Exchange Questions
Is depreciation recapture taxed at the same rate as the rest of the capital gain?
No. Recapture on real property is taxed federally at a rate capped at 25 percent, which is generally higher than the standard long-term capital gains rate applied to the appreciation portion of the same sale.
Can a property owe recapture tax even if it sells at a loss compared to its original purchase price?
Yes, in some cases. Recapture is based on depreciation actually claimed against the property, not on whether the sale was profitable overall, so heavily depreciated property can generate recapture even in a modest or break-even sale.
Does a cost segregation study increase the depreciation recapture owed at sale?
It typically increases the recapture component specifically, since accelerating depreciation during the hold lowers the property's remaining basis faster, which produces a larger recapture figure when the property eventually sells.
Can a 1031 exchange defer depreciation recapture in New York City?
Yes. When a sale is structured as a qualifying exchange, both the appreciation gain and the depreciation recapture are deferred together, carrying forward into the replacement property's basis rather than being taxed at the time of sale.
How can an owner estimate recapture before deciding whether to sell?
An accountant can calculate accumulated depreciation from the property's tax returns and apply the recapture rate to produce a working estimate. Getting this figure early, well before a listing goes live, gives an owner time to decide whether an exchange or an installment structure is worth pursuing.
