Real estate investors using STR tax strategies can unlock major tax savings through bonus depreciation. But when it’s time to sell, one big surprise catches many off guard: depreciation recapture.
What Is Depreciation Recapture?
When you sell a rental property, the IRS claws back a portion of your previously claimed depreciation as taxable income. The rate depends on how the assets were depreciated and will vary for things like appliances, building structure, and gains from the property’s price appreciation over time.
A Simple Example
Let’s say an investor buys a STR in 2022 for $600,000.
Then, they hire a specialist to do a cost segregation study, allowing them to immediately write off $150K in bonus depreciation that same year.
This large paper loss helps reduce their taxable W-2 income, saving them around $48,000 in federal taxes that year, if they’re in the 32% bracket.
What Happens When the Property Is Sold
Three years later, in 2025, the investor sells the property.
By then:
- They wrote off $150K through bonus depreciation (year 1)
- They also claimed another ~$27K of regular depreciation over the next 3 years
- Total depreciation taken = ~$177K
Now the IRS wants some of that tax savings back.
This is called depreciation recapture, and it’s taxed differently than normal capital gains. To keep things simple:
If the investor is still in the same 32% tax bracket, the total tax just on depreciation recapture is about $54,730.
3 Strategies to Offset or Defer Recapture
#1 Use Passive Activity Loss (PAL) Carryforwards
Review past tax returns for suspended PALs. These passive losses, which are often unusable in high-income years, can be unleashed to offset recapture income when the property sells.
#2 Complete a 1031 Exchange
Swap the property for another of equal or greater value and defer both capital gains and recapture. This strategy is ideal for scaling up without paying taxes now.
#3 Leverage a “1031 Lite” with Bonus Depreciation
If a full 1031 exchange isn’t feasible, buy a new property in the same tax year and conduct a cost seg study. The resulting bonus depreciation can offset gains and recapture from the previous sale without the rigid 1031 timeline.
Bottom Line
Yes, depreciation recapture reduces your windfall when you sell the property, but the upfront savings and reinvestment potential often outweigh the future tax hit.
The core principle here is the time value of money: having immediate access to that $48K means more investment opportunities now, allowing you to compound growth and maximize returns for as long as you own the property, instead of giving it immediately to the IRS.
The key is knowing the recapture’s coming and planning around it. With the right strategy, you can reduce, defer, or even eliminate the worst of the damage.
This was a summary, for educational purposes. Read the full article on this topic Here, written by Gabriel Virdaru, CPA.
