Depreciation and Recapture

How it works

Depreciation turns the cost of an income-producing building into an annual ordinary deduction. Section 167(a) is what allows the deduction in the first place; section 168, the modified accelerated cost recovery system, supplies the method, the recovery period and the timing convention that decide how much of it lands in any given year. The deduction shelters rental income that would otherwise be taxed at ordinary rates, for as long as the recovery period runs.

Land never depreciates. Only the building and the improvements on it recover, so the first real decision is how to divide the purchase price between the two. A county property appraiser's assessed land-to-improvement ratio is the usual starting point, and an appraisal or the structure's insurable value works as well. The split has to be defensible on its own, independent of whatever recovery period follows from it.

None of this is free money. Every dollar of depreciation deducted reduces the building's basis by the same dollar, so the deduction is fundamentally a deferral rather than a permanent exclusion. What makes it worth doing anyway is a mix of time value and rate arbitrage: the deduction shelters income now, at ordinary rates, while the specific slice of gain it creates is recaptured later at a capped rate rather than the full ordinary rate.

Section 1250 only recaptures "additional depreciation," meaning depreciation claimed in excess of straight-line. MACRS requires straight-line on real property with no accelerated alternative available, so there is never any excess to recapture, and therefore never any ordinary income recapture under section 1250 on the building shell itself. Instead, that straight-line depreciation converts at sale into "unrecaptured section 1250 gain," a category of long-term capital gain taxed at a maximum 25 percent rate rather than the regular 0, 15 or 20 percent rate that applies to the rest of the gain. Depreciation claimed on components a cost segregation study has reclassified out of the building and into personal property is a different animal: that portion is section 1245 property, and gain attributable to it is ordinary income to the full extent of the depreciation taken, with no 25 percent ceiling at all. I go through that reclassification on its own in cost segregation. Any gain left over once all of the depreciation has been accounted for is section 1231 gain, taxed as long-term capital gain.

What this is worth in Florida

For an individual investor here, there is no state income tax sitting on top of any of this. The federal analysis above is the whole analysis; rental income was never going to be taxed a second time at the state level, and neither is the recapture when the property eventually sells. The state-level touchpoints that remain are ordinary ones, sales tax on furnishings and equipment bought for the property and the usual entity paperwork, not anything that changes the depreciation or the recapture math itself.

Who this applies to

The property has to be used in a trade or business, or held for the production of income. A personal residence is not depreciable at all; a rental, an office building, or the rented portion of a mixed-use property is.

Once a property clears that bar, the recovery period is fixed by what the property is, not by anything the owner chooses:

• Residential rental property recovers over 27.5 years, straight-line, under a mid-month convention. "Residential" carries its own test: at least 80 percent of the property's gross rental income has to come from dwelling units, or it falls into the other category instead.
• Nonresidential real property recovers over 39 years, also straight-line, also mid-month.

The method is not a choice either. Real property depreciates straight-line by statute, and no accelerated method is available on the shell itself. That single fact is what drives the recapture outcome covered under "Where it goes wrong" below.

The mid-month convention treats the month a property is placed in service as a half month of depreciation, regardless of what day inside that month it actually happened.

Bonus depreciation and the section 179 election do not reach the 27.5- or 39-year shell at all. Both apply to personal property and to certain qualifying real-property components instead, which is a separate inquiry from ordinary building depreciation and usually depends on a cost segregation study having been done first. The baseline recovery-period rules for Florida owners are in my Florida depreciation rules guide, and the expensing election for personal property is in my Section 179 guide.

What it requires

A defensible basis allocation between land and building comes first, and it has to be documented at acquisition rather than reconstructed years later once it is being questioned. A building-heavy split with nothing behind it but the owner's preference is an obvious target on examination.

The placed-in-service date is whenever the property is ready and available for its assigned use, meaning advertised or listed for rent, not the closing date and not the date a first tenant actually moves in. Depreciation starts running from that date under the mid-month convention described above.

Whether a cost gets deducted now or capitalized and depreciated turns on a single test. Under the regulations, an amount must be capitalized if it betters the property, restores it, or adapts it to a new use, the "BRA" test. Everything else is a currently deductible repair. The unit of property for this test is the building itself and each of its enumerated systems, HVAC, plumbing, electrical, escalators, elevators, fire protection, security and gas distribution among them, so an expenditure that looks minor against the whole building can still be a capitalizable restoration of just one system.

Three safe harbors soften that line, and each one runs on its own annual election:

• The de minimis safe harbor lets an owner deduct outright anything at or below $5,000 per invoice or item with an applicable financial statement, or $2,500 without one. It requires a written accounting policy in place at the start of the year, and an election statement attached to the return, every year, not just the first one.
• The routine maintenance safe harbor treats maintenance reasonably expected to recur more than once in the ten years after the property is placed in service as not an improvement at all, regardless of what it costs.
• The small-taxpayer safe harbor is available on a building with an unadjusted basis of $1,000,000 or less, for a taxpayer averaging $10,000,000 or less in annual gross receipts, and it covers annual building expenditures up to the lesser of $10,000 or two percent of the building's unadjusted basis. It is also an annual election.

When a whole building component comes out of service before the building itself sells, a full roof, a full HVAC system, a partial disposition election writes off whatever basis is left on the retired piece in the year of replacement. Skip the election and the old component keeps depreciating on paper right alongside its replacement, which is easy to miss and simply wrong once noticed.

What you need to document

The basis allocation, from day one

The assessor ratio, appraisal, or insurable-value analysis supporting the land-to-building split, kept in the file at acquisition rather than assembled later.

Placed-in-service evidence

Whatever shows the property was actually ready and advertised for rent on the date claimed, separate from the closing statement and separate from the first lease.

The unit-of-property analysis behind any capitalized cost

A record of why a given expenditure was a betterment, restoration or adaptation to a specific building system, not just a note that it was expensive.

Every safe-harbor election, every year

The written accounting policy behind the de minimis safe harbor has to exist at the start of the year, and its election statement has to be attached to that year's return. The small-taxpayer election works the same way. Neither one carries forward on its own.

Support for any partial disposition

The identity of the retired component, its placed-in-service date, and its adjusted basis at the time it came out of service.

A depreciation schedule that is actually current

Basis is reduced by depreciation that was allowed or merely allowable, whether or not it was claimed, so a schedule with gaps in it is not a safe place to leave things.

Where it goes wrong

Straight depreciation and its recapture are routine; this is not a listed or reportable transaction, and no one is examining the concept itself. The exposure lives in a handful of specific, recurring spots.

The recapture that shows up uninvited

The first is forgetting that depreciation is "allowed or allowable." Basis goes down by the depreciation that should have been claimed even in a year it was skipped, so skipping it does not avoid anything. It just creates a phantom deduction that still gets recaptured at sale without ever having sheltered any income along the way. The fix for missed depreciation is a formal accounting method change on Form 3115, not an amended return, and the two are not interchangeable.

The second is the cost segregation surprise. Accelerating components into 5-, 7- or 15-year classes reclassifies them as section 1245 property, and depreciation on that portion comes back as ordinary income with no 25 percent cap when the property sells. That trims the strategy's net value against the plain first-year deduction, and it needs to be sized before recommending an aggressive study, not discovered afterward. The mechanics of the reclassification itself are in cost segregation.

The third is assuming an exit makes the recapture disappear, and it is worth being precise about which one actually does. An exchange under section 1031 defers the building's unrecaptured section 1250 gain into the replacement property. It does not erase it. That gain stays attached to the exchanged basis and will still be sitting there, measured against the new property, whenever it finally sells. The only exit that actually erases it is dying while still holding the property: section 1014 steps the heir's basis up to fair market value, and the depreciation history behind it does not survive the transfer. None of this reaches the personal property a cost segregation study creates. I treat that recapture as a separate question in cost segregation, not as an extension of this one.

The recurring mistakes

• A land allocation with nothing behind it. A building-heavy split with no appraisal or assessor support invites the excess depreciation to be reallocated and disallowed.
• Expensing an improvement as a repair. A full roof or HVAC replacement is a restoration of a building system under the BRA test, not routine upkeep, and it has to be capitalized rather than deducted in one year.
• A safe harbor claimed without its election. The written policy has to exist at the start of the year, and the election statement has to be attached to that specific year's return. Getting the substance right and skipping the paperwork loses the safe harbor anyway.
• Missing the binding-contract date on bonus depreciation. The current 100 percent bonus rate reaches qualifying property acquired and placed in service after January 19, 2025. Property under a written binding contract entered before January 20, 2025 is generally not eligible for the full rate (transitional elections aside), and the contract date controls, not the placed-in-service date.

A situation where this comes up

The straightforward version is an owner who has held a rental for a decade, kept the assessor's land allocation and every renovation invoice on file, and replaced the roof three years ago with a properly filed partial disposition election on the old one. When that property finally sells, the recapture is not a surprise. It was modeled into the exit before the property went on the market, and the only real decision left is whether to take the unrecaptured gain now or roll it into another property through an exchange.

The version that goes sideways is the owner who calls after already signing a contract to sell. There was never an appraisal behind the original land split, a full roof replacement from a few years back was deducted in one year as a repair, and depreciation was skipped for two years in the middle when the property ran at a loss. None of those choices were caught at the time, and all three show up at once now: a thin allocation with no support, an improvement that should have been capitalized, and basis that is lower than the return shows because the skipped years still count. There is far less room to fix any of it three weeks from closing than three years earlier.

The third pattern is the investor who has heard that an exchange solves this and stops there. It defers the building's piece of it into the next property; it does not make it disappear. Whether personal property a cost segregation study created gets the same treatment is a different question, and it is not this one. I would settle that separately before counting on it, not after the exchange has already closed.