Depreciation Recapture When You Sell a Short-Term Rental
Depreciation Recapture When You Sell a Short-Term Rental (and How to Plan Around It)
By: Menandro Bacalangco Jr. | October 13, 2026
Depreciation Recapture Short-Term Rental: Tax Deductions
Selling a short-term rental can create a larger tax bill than many real estate investors expect, particularly after claiming significant depreciation deductions through cost segregation or bonus depreciation.
These deductions can reduce taxable income during ownership. However, they also generally reduce the property's adjusted tax basis, which can increase taxable gain when the investment is sold.
This is where depreciation recapture becomes important.
For Airbnb and vacation rental owners, the tax consequences depend on the type of real estate, accumulated depreciation, asset classifications, and gain recognized at sale.
Understanding short-term rental taxation means considering both the deductions available during ownership and the potential income tax consequences at disposition.
The goal is not simply to maximize tax savings today. It is to understand how depreciation affects the investment's lifetime after-tax return.
TL;DR: Depreciation Recapture for STR Owners
- Depreciation reduces adjusted basis, potentially increasing taxable gain when selling rental property.
- Section 1245 recapture generally applies to certain personal property and can be taxed at ordinary income rates.
- Unrecaptured Section 1250 gain generally applies to qualifying depreciation-related real estate gains and has a maximum 25% federal rate for individuals.
- Cost segregation can accelerate depreciation deductions but may change the character of gain when selling.
- Suspended passive losses may become deductible when an entire passive activity is sold in a qualifying transaction.
- 1031 exchanges and installment sales may defer certain gains, although important restrictions apply.
The key is to evaluate depreciation benefits and sale-year tax consequences together.
What Depreciation Recapture Is
Depreciation allows real estate owners to recover the cost of qualifying rental assets through annual tax deductions.
For short-term rentals, depreciable assets may include buildings, furniture, appliances, equipment, and certain improvements.
Through accelerated depreciation, some qualifying assets generate deductions earlier in the ownership period.
While these deductions may create meaningful tax benefits, they also generally reduce the property's adjusted basis.
When the rental property is eventually sold, that lower basis can increase taxable gain.
How adjusted basis affects your sale
Adjusted basis generally begins with the original tax basis, increases for qualifying capital improvements, and decreases for depreciation allowed or allowable and other required adjustments.
Adjusted basis = Original basis + qualifying improvements − depreciation allowed or allowable − other basis reductions
For example:
| Item | Amount |
|---|---|
| Original depreciable basis | $700,000 |
| Accumulated depreciation | −$150,000 |
| Adjusted depreciable basis | $550,000 |
The $150,000 reduction in basis can increase taxable gain when the depreciated assets are sold.
However, depreciation recapture is not always equal to the total depreciation claimed. The actual tax treatment depends on the property classification and recognized gain.
The allowed-or-allowable rule
Under IRC §1016(a)(2), basis generally must reflect depreciation that was allowed or allowable, subject to the applicable rules.
This means investors cannot necessarily avoid depreciation-related gain by choosing not to claim deductions.
Accurate depreciation records are therefore essential, even when an earlier tax return omitted allowable expenses.
Sources: IRS Publications 551 and 544.
§1250 vs. §1245 Recapture on an STR
The most important distinction in depreciation recapture rental property calculations is how different depreciable assets are classified.
A furnished STR may include both Section 1250 real estate and Section 1245 personal property.
These categories can produce different income tax consequences.
Section 1250: Buildings and real property
The rules under IRC Section 1245 and IRC Section 1250 distinguish ordinary-income recapture on certain depreciable assets from the treatment of depreciation-related real property gains.
When a building has been depreciated using straight-line depreciation, the resulting depreciation-related long-term gain generally does not create ordinary-income Section 1250 recapture.
Instead, qualifying gain may be classified as unrecaptured Section 1250 gain, subject to a maximum federal tax rate of 25% for individuals.
This is not necessarily a flat 25% tax. The applicable rate depends on the taxpayer's circumstances.
Certain depreciation exceeding the applicable straight-line amount can still trigger ordinary-income Section 1250 recapture.
Section 1245: Personal property and equipment
Section 1245 generally applies to depreciable personal property and certain other specified assets.
Common examples associated with short-term rentals include:
- Furniture and appliances
- Equipment and removable furnishings
- Certain qualifying property components
- Other assets properly classified under Section 1245
When Section 1245 property is sold at a gain, the gain is generally treated as ordinary income to the extent of applicable depreciation adjustments.
For example, furniture purchased for $30,000, fully depreciated, and later sold for $10,000 may generate $10,000 of ordinary-income recapture.
The entire original depreciation deduction is not automatically recaptured.
Comparing Section 1245 and Section 1250
| Factor | Section 1245 | Unrecaptured Section 1250 Gain |
|---|---|---|
| Common assets | Furniture, equipment, appliances | Depreciated buildings |
| Tax treatment | Ordinary income to extent recaptured | Maximum 25% federal rate for individuals |
| Main consideration | Gain and depreciation history | Qualifying gain and real property depreciation |
| Cost segregation impact | Often affects shorter-lived assets | Changes basis allocated to buildings |
Remaining qualifying gain may receive Section 1231 treatment, potentially resulting in long-term capital gains rates after applicable netting and lookback rules.
Important: Unrecaptured Section 1250 gain is different from ordinary-income Section 1250 recapture.
Source: IRC §§1231, 1245, and 1250; IRS Publication 544.
How Cost Segregation Changes the Sale Math
A cost segregation study identifies qualifying real estate components and personal property that may be depreciated over shorter recovery periods.
Instead of treating every improvement as part of a longer-lived building, cost segregation separates eligible assets into the appropriate depreciation categories.
For real estate investors, this can accelerate deductions and improve near-term cash flow.
However, faster depreciation also generally reduces adjusted basis earlier, potentially changing the tax treatment when the rental investment is sold.
Does cost segregation increase recapture?
Potentially.
Cost segregation can identify more assets subject to Section 1245 recapture. When those assets are sold at a gain, ordinary-income tax treatment may apply.
The actual recapture depends on:
- Accumulated depreciation
- Adjusted tax basis
- Asset classification
- Allocated selling price
- Recognized gain
- Applicable recapture limitations
An evaluation of whether cost segregation is worth it for an Airbnb should compare upfront tax benefits with potential depreciation recapture at sale.
How bonus depreciation affects the outcome
The IRS explains the applicable recovery periods and special depreciation allowances in Publication 946. Qualifying property acquired and placed in service after January 19, 2025, may generally be eligible for 100% bonus depreciation, subject to applicable requirements and elections.
Bonus depreciation can create substantial tax savings by accelerating the depreciation deduction for eligible assets.
However, fully depreciated property may have a zero adjusted basis, increasing potential gain when sold.
Consider this example:
| Furniture Example | Amount |
|---|---|
| Original cost | $40,000 |
| Depreciation claimed | −$40,000 |
| Adjusted basis | $0 |
| Allocated sale price | $15,000 |
| Potential Section 1245 recapture | $15,000 |
Illustrative example assuming full eligibility, a supportable sale allocation, and no other adjustments.
The potential recapture is $15,000, not the entire $40,000 previously deducted.
This distinction matters because early depreciation benefits may retain value even when some gain is later taxed.
Worked Example: Sale After Four Years
Consider a real estate investor who purchases a furnished short-term rental for $1 million, completes a cost segregation study, and sells the property four years later for $1.2 million.
Illustrative example — not an actual tax return.
Step 1: Establish the original basis
| Asset Category | Original Basis |
|---|---|
| Land | $200,000 |
| Building | $600,000 |
| Section 1245 personal property | $200,000 |
| Total | $1,000,000 |
Assume the personal property is fully depreciated and the building accumulates $80,000 in straight-line depreciation.
The building figure is a simplified assumption, not a prescribed four-year MACRS schedule.
Step 2: Calculate adjusted basis
| Asset | Original Basis | Depreciation | Adjusted Basis |
|---|---|---|---|
| Land | $200,000 | $0 | $200,000 |
| Building | $600,000 | $80,000 | $520,000 |
| Personal property | $200,000 | $200,000 | $0 |
| Total | $1,000,000 | $280,000 | $720,000 |
The investor has claimed $280,000 in accumulated depreciation, reducing the combined adjusted basis to $720,000.
Step 3: Calculate the taxable gain
Assume the selling price is allocated using reasonable, supportable asset values.
| Asset | Sale Price | Adjusted Basis | Gain |
|---|---|---|---|
| Land | $300,000 | $200,000 | $100,000 |
| Building | $800,000 | $520,000 | $280,000 |
| Personal property | $100,000 | $0 | $100,000 |
| Total | $1,200,000 | $720,000 | $480,000 |
The investor realizes a total gain of $480,000 before selling expenses and other adjustments.
Step 4: Separate the gain categories
| Gain Category | Amount | Potential Tax Treatment |
|---|---|---|
| Section 1245 recapture | $100,000 | Ordinary income |
| Unrecaptured Section 1250 gain | $80,000 | Maximum 25% federal rate category |
| Remaining Section 1231 gain | $300,000 | Potential long-term capital gain treatment |
| Total | $480,000 | Multiple tax categories |
Although the rental property's total value increased by $200,000, depreciation reduced the adjusted basis and increased the tax gain to $480,000.
Assuming the personal property gain is entirely subject to Section 1245, $100,000 is ordinary income.
Assuming the building depreciation is entirely straight-line and other requirements are satisfied, $80,000 may be unrecaptured Section 1250 gain.
The remaining $300,000 may qualify for Section 1231 treatment.
This example demonstrates why accumulated depreciation does not automatically translate into an equal amount of ordinary-income recapture.
Each asset's classification, depreciation history, and gain determine the result.
What Happens to Suspended Passive Losses at Sale?
Some real estate investors generate rental losses that cannot be deducted immediately because of passive activity limitations.
These deductions may carry forward as suspended passive losses.
Under IRC §469(g), suspended passive losses may become deductible when an investor disposes of an entire interest in a passive activity through a fully taxable transaction to an unrelated party.
Consider this example:
| Item | Illustrative result |
|---|---|
| Suspended passive losses | $70,000 |
| Entire activity sold | Yes |
| Fully taxable transaction | Yes |
| Unrelated buyer | Yes |
| Potentially deductible losses | Up to $70,000 |
The actual deductible amount depends on the investor's income, other passive activities, and applicable loss limitations.
Released passive losses may reduce overall taxable income without changing the statutory character of Section 1245 recapture.
How material participation affects passive losses
The distinction between active participation and material participation matters when determining how rental losses are treated.
Some short-term rentals qualify for an exception from the rental-activity definition under Section 469. For those activities, material participation can determine whether income or losses are passive.
Investors who failed to meet the applicable participation requirements may have accumulated passive losses over previous years.
A qualifying disposition can affect when those losses become deductible, but a partial sale or certain tax-deferred transactions may not provide the same treatment.
Previous passive losses also require separate analysis if an activity later becomes nonpassive.
Source: IRC §469(g) and IRS Publication 925.
Ways to Defer or Reduce Depreciation Recapture
Real estate investors have several potential strategies for managing taxes when selling rental property.
However, these strategies do not automatically eliminate depreciation recapture. Each has separate eligibility requirements and limitations.
1. Consider a 1031 exchange
A qualifying Section 1031 exchange may defer gain when eligible investment or business real estate is exchanged for like-kind real property.
However, personal property generally does not qualify for this treatment.
For a furnished STR, appliances, furniture, and certain equipment identified through cost segregation may produce taxable gain even when the real property portion qualifies for deferral.
A 1031 exchange involving a vacation rental requires careful attention to investment use, personal use, and exchange deadlines.
The interaction between qualifying real estate and separately taxable assets is also relevant to 1031 exchange advisory.
Importantly, some assets treated as Section 1245 property for depreciation purposes may qualify as real property under separate Section 1031 regulations. Classification must be examined individually.
Source: IRC §1031 and Treasury Regulation §1.1031(a)-3.
2. Evaluate an installment sale
An installment sale generally involves receiving at least one payment after the tax year of the sale.
Eligible gain may be recognized as payments are received, potentially spreading certain income tax consequences across several years.
However, ordinary-income depreciation recapture generally must be reported in the year of sale, even if the investor receives payment later.
For example, if a transaction produces $50,000 in Section 1245 recapture, that ordinary income generally remains reportable in the sale year.
Other eligible gains may qualify for installment reporting.
Real estate investors should also consider interest, financing terms, buyer default risk, and available cash for tax payments.
Source: IRC §453(i) and IRS Publication 537.
3. Consider holding the property longer
A longer ownership period may provide additional rental income, appreciation, and more time to benefit from earlier tax savings.
However, holding real estate longer does not automatically eliminate depreciation recapture.
Previously allowed or allowable depreciation generally continues to reduce the adjusted basis of the rental property.
The decision should therefore compare expected after-tax proceeds from selling with the potential income, expenses, risks, and returns of continued ownership.
4. Understand the step-up in basis at death
Under IRC §1014, qualifying property acquired from a decedent generally receives a tax basis determined by its fair market value at death, subject to applicable exceptions.
This adjustment may substantially change the income tax consequences of a later sale, including the impact of depreciation claimed by the prior owner.
However, the treatment depends on ownership structure, estate-planning arrangements, and the manner in which the property transfers.
A step-up in basis is an estate-planning consideration rather than an automatic election available to investors selling during their lifetime.
5. Account for the 3.8% Net Investment Income Tax
The Net Investment Income Tax (NIIT) may impose an additional 3.8% federal tax on certain net investment income when a taxpayer's modified adjusted gross income exceeds the applicable threshold.
Gain from selling a passive STR activity may be included in net investment income.
However, not every short-term rental disposition automatically triggers NIIT.
The material participation tests help determine whether an activity is passive under Section 469.
Material participation alone does not settle every NIIT question. The activity's trade or business classification and the applicable disposition rules must also be considered.
For investors with multiple rental activities or substantial real estate income, NIIT can meaningfully affect the after-tax proceeds from selling.
Source: IRC §1411 and IRS guidance on the Net Investment Income Tax.
How to Prepare Before Selling Your Short-Term Rental
A depreciation recapture projection is most useful before the transaction is finalized.
For real estate investors, accurate accounting records help identify the depreciation deductions claimed during ownership and the adjusted tax basis remaining at sale.
A useful pre-sale checklist includes:
- Review depreciation schedules. Confirm original cost basis, accumulated depreciation, and adjusted basis for each asset.
- Examine cost segregation records. Identify Section 1245 property, Section 1250 real estate, and any other relevant classifications.
- Evaluate selling price allocations. Assign supportable values to land, buildings, furniture, appliances, and equipment.
- Review passive losses. Determine whether suspended losses may become deductible following a qualifying disposition.
- Calculate potential taxes. Separate ordinary-income recapture, unrecaptured Section 1250 gain, Section 1231 gain, NIIT, and applicable state taxes.
- Compare sale structures. Evaluate the consequences of an outright sale, installment sale, or qualifying 1031 exchange.
Accurate investor accounting helps maintain depreciation schedules, asset records, and basis adjustments needed for these calculations.
Investors should also account for selling expenses, qualifying improvements, missed deductions, and other factors affecting taxable gain.
The overall goal is to estimate the investment's after-tax proceeds rather than focusing only on its selling price.
Final Thoughts: Plan the Exit, Not Just the Deduction
Depreciation can provide valuable benefits to short-term rental investors by accelerating deductions and improving cash flow during ownership.
However, claiming substantial depreciation today can also affect the amount and character of gain recognized when selling.
Section 1245 recapture may generate ordinary income, while unrecaptured Section 1250 gain and remaining Section 1231 gain may receive different tax treatment.
Passive losses, material participation, transaction structure, and NIIT can further influence the final tax consequences.
A comprehensive short-term rental tax strategy considers these factors throughout the investment lifecycle, from acquisition through disposition.
The goal is not simply to maximize depreciation deductions. It is to understand how those deductions affect the property's lifetime after-tax return.
Frequently Asked Questions
Does cost segregation increase depreciation recapture?
Potentially. Cost segregation can accelerate depreciation and may increase the amount of gain subject to ordinary-income Section 1245 recapture. However, the actual amount depends on the adjusted basis, depreciation history, asset classification, and gain recognized when selling.
Is depreciation recapture taxed as ordinary income?
Not always. Section 1245 recapture is generally taxed as ordinary income. Qualifying unrecaptured Section 1250 gain generally has a maximum federal tax rate of 25% for individuals. Certain other Section 1250 recapture amounts may also be ordinary income.
Can a 1031 exchange avoid depreciation recapture?
A qualifying exchange may defer certain gains on eligible real estate. However, personal property generally does not qualify. Some assets identified through cost segregation may therefore generate taxable gain even when the investment property qualifies for a like-kind exchange.
What happens when you sell a fully depreciated rental property?
A fully depreciated asset generally has a zero adjusted basis before other applicable adjustments. Selling that asset for a positive amount can create taxable gain. The character of the gain depends on the asset classification, depreciation history, and applicable tax rules.
What is the maximum tax rate for depreciation recapture on real estate?
Qualifying unrecaptured Section 1250 gain is generally subject to a maximum 25% federal rate for individuals. Ordinary-income recapture, including Section 1245 recapture, may be subject to higher ordinary income rates. NIIT and state income taxes may also apply.
Can suspended passive losses offset gain when selling?
Potentially. Suspended passive losses may become deductible following a qualifying fully taxable disposition of an entire passive activity to an unrelated party. The actual deduction depends on the taxpayer's circumstances and other applicable limitations.
How do I calculate depreciation recapture before selling?
Start with the adjusted basis and accumulated depreciation for each asset. Allocate anticipated sale proceeds, calculate gain or loss by asset, and apply the appropriate Sections 1245, 1250, and 1231 rules. Then consider selling expenses, passive losses, NIIT, and other applicable provisions.
