Hypothetical - how are these tax calculations done?

Question

Good afternoon all!

I was having a discussion with someone regarding tax and depreciation recapture on a short term rental property and we had a difference of opinion. In order to keep it fair I'm not going to post my take on how this is calculated, but just put out the (basic) facts here, rounded for ease of math.

Property was purchased 5 years ago for 500k including all deductible/depreciable closing costs, with a property basis of 90% ($450k). That same year the client did a cost segregation for $200k in bonus depreciation for tax purposes bringing the remaining basis to $250k (about 6500 annual depreciation, $32,500 over 5 years on a 39 year schedule). 5 years later the property is sold for a loss, $450k after deducting cost of sale. What is the taxable amounts owed on any profit or loss, and what depreciation gets recaptured and taxed at ordinary income rates or the fixed 25%?

I believe I already know the answer(s) but I am not a tax professional, and someone else (also not a tax professional but knowledgeable) says I'm wrong - so I put it to the excellent jury here in the forum.

Aaron Zimmerman · Answer

Adjusted basis = 500,000 - 232,500 = 267,500

Sales price = 450k.

gain = 182,500

youd have to allocate a portion to land, 1245 property, and 1250 property. There's no one size fits all here but a substantial amount of that gain would be subject to depreciation recapture since it's sold at a tax gain. The question would be how much to 1245 recapture vs 1250 recapture. Any excess depreciation over straight line would be taxed effectively at ordinary income rates.

Gregory Wilson · Answer

This is a great tax puzzle — and the most important finding here is that the premise of "sold for a loss" needs to be examined carefully before getting to the recapture question, because it's actually the crux of the whole dispute.

Step 1: What Is the Adjusted Basis at Sale?

Item

Amount

Original basis

$500,000

Less: §1245 bonus depreciation (cost seg)

($200,000)

Less: §1250 straight-line depreciation (5 yrs × ~$6,500)

($32,500)

Adjusted basis at time of sale

$267,500

Step 2: Is There Actually a Gain or a Loss?

• Amount realized: $450,000
• Adjusted basis: $267,500
• Result: a gain of $182,500

This is the key issue. The property was sold below its original purchase price ($450k < $500k), but that is economically irrelevant for tax purposes. Because of the $232,500 in total depreciation taken, the adjusted basis dropped to $267,500 — so the IRS sees a $182,500 taxable gain, not a loss.

Step 3: How Is That Gain Taxed?

§1245 recapture (ordinary income):
§1245 recapture equals the lesser of:

• Total §1245 depreciation taken = $200,000
• Total gain recognized = $182,500

→ §1245 recapture = $182,500, all taxed as ordinary income

Unrecaptured §1250 gain (25% rate):
The $32,500 in straight-line real property depreciation would create unrecaptured §1250 gain — but only to the extent there is remaining gain after §1245 absorbs its share. Since §1245 consumed the entire $182,500 gain, there is nothing left.

→ Unrecaptured §1250 = $0

§1231 long-term capital gain:
→ $0 — no remaining gain.

Summary Table

Category

Amount

Rate

§1245 recapture

$182,500

Ordinary income

Unrecaptured §1250 gain

$0

25%

§1231 gain (LTCG)

$0

Preferential

Total taxable gain

$182,500

The Likely Point of Disagreement

The other person may be arguing that some portion of the gain is taxed at the 25% unrecaptured §1250 rate (for the straight-line depreciation) rather than all of it being ordinary income. That would be incorrect here because §1245 absorbs gain first, and the §1245 depreciation ($200k) exceeds the total gain ($182,500), leaving nothing on the table for §1250 treatment.

The other common error is thinking the $50,000 "economic loss" (purchase price minus net sale price) produces any tax benefit — it does not, because the tax basis is the adjusted basis, and the depreciation deductions were already taken as a benefit in prior years. That's the entire point of recapture.

One practical footnote: while this analysis treats the sale as a single asset disposition (which is the typical approach when there's no separate allocation in the purchase agreement), a rigorous cost-seg-by-cost-seg allocation could theoretically shift some numbers. But the aggregate outcome under a reasonable analysis lands here.

Elaine Park · Answer

CPA here. The confusion in this thread is the same thing I see with clients every tax season, so let me walk through it.

The property was NOT sold at a loss for tax purposes. It was sold at a cash loss, yes, $50K less than purchase price. But once you subtract the $232,500 in total depreciation from the original basis, the adjusted basis is $267,500. Selling for $450K means there's a $182,500 taxable gain. That's the number the IRS cares about.

Now for the recapture breakdown. The $200K in bonus depreciation from the cost seg is Section 1245 property, things like appliances, fixtures, cabinetry, flooring, site improvements. When you sell, any gain attributable to those items gets recaptured at your ordinary income tax rate. Not the 25% rate, your full marginal rate. The remaining $32,500 of straight-line depreciation on the building itself is Section 1250 property, and that gets recaptured at a maximum of 25%.

Allocating the sale price across land, 1245, and 1250 buckets is the tricky part. Aaron is right that it depends on the facts. If you held for 5 years, those cost seg items still have some value, so you'd allocate a portion of the sale price to them. In practice, I've had clients work with their appraiser to get a personal property allocation at sale that's defensible. If you don't do that allocation, the IRS can do it for you, and they won't be generous about it.

On the "no recapture on a loss" comment, that rule applies when the property is sold below adjusted basis. Here, adjusted basis is $267,500 and the sale price is $450K, so there IS a gain and there IS recapture. The fact that the investor "lost money" compared to what they paid doesn't matter for tax purposes. This is the exact scenario that catches investors off guard after a big cost seg, they feel like they lost money on the deal but still owe a significant tax bill.

Rough math at a 30% marginal rate: somewhere in the $50K-$60K range in total tax, depending on how the sale price allocation shakes out between 1245 and 1250 property. Not a small number on a deal where you walked away with less cash than you started with. This is why I tell my clients to model the exit tax before they do a cost seg, not after.

Greg Scott · Answer

I'm not a CPA either.

I would assume whatever depreciation was used (as opposed to unused carry-forward) would have to be recaptured at ordinary income and long-term capital gains would be zero.

If they used all the depreciation and are in the 30% tax bracket, it looks like they are looking at around $70,000 tax bill on a property in which they lost money.

Greg Scott · Answer

Even though you sold the property for $50k less than you paid, you owe $54,750 in taxes.

The Breakdown:

• Economic Reality: You bought for $500k and sold for $450k ($50k cash loss).
• Tax Reality: Because you took $232,500 in depreciation, your tax basis dropped to $267,500. This creates a $182,500 taxable gain.
• The Tax Bill: Since your bonus depreciation (Section 1245) exceeds your total gain, the entire $182,500 is taxed as ordinary income.
• Final Math: $182,500 x 30% = $54,750

Chris Seveney · Answer

I had no clue but ran it through AI and it mentioned 1245 and 1250 rules. I know am guessing you owe something as I've seen many MF syndicator's, who took accelerated depreciation and when they lost it all the investors still had a tax liability which was salt on the wound. What a scary is the only person who said nothing was owed in this current chat I believe is a CPA..

Malik Javed · Answer

JD – In your scenario, the building portion ($200K) is depreciated over 39 years, which comes out to roughly $5K per year. Over a 5-year hold period, that totals about $25K–$30K of regular depreciation.

Additionally, if I am correct, the cost segregation portion ($250K) is taken upfront as bonus depreciation (assuming 100% bonus).

So, in total, the depreciation would be approximately $275K.

Upon sale:

• The $250K bonus depreciation is recaptured and taxed at ordinary income rates (Section 1245 recapture).
• The ~$25K of regular depreciation is taxed at up to 25% (Section 1250 recapture).
• Any remaining amount would be treated as capital gain (which is minimal or none in this case).

I hope this helps.

Jason Malabute · Answer

A property can be sold at a cash loss but still generate a taxable gain because depreciation reduces the adjusted basis. When the sale price exceeds that adjusted basis, the IRS treats it as a gain regardless of the investor’s actual cash outcome.

Depreciation taken—especially from cost segregation—gets recaptured upon sale. Accelerated (Section 1245) depreciation is taxed at ordinary income rates, while straight-line (Section 1250) depreciation is generally capped at 25%. The allocation of the sale price across asset categories (land, 1245, 1250) directly impacts the tax bill and can significantly increase what’s owed.

The key takeaway: depreciation can create a situation where you feel like you lost money but still owe substantial taxes, so exit tax planning should be modeled before doing a cost segregation, not after.

Natalie Kolodij · Answer

Rough Math- $500k-$200k-$32,500= $267,500 adjusted basis $450k-$267,500= $182,500 gainA few notes/thoughts - 1245 Assets (bonus qualifying) subject to 1245 recapture at ordinary tax rate1250 Assets (39 year) subject to UNrecaptured 1250 gain 25% (we rarely have 1250 recapture) If there's an appraisal or an exist cost study done to establish little to no remaining value left in some of those shorter-life 1245 assets, those can potentially be allocated less of the gain and the numbers can change. Also 45% identification on 1245 assets from a cost seg study  on a residential property is 15-20% above the norm. And 90% building value somewhere with $500k properties also makes me raise an eye brow. So for the sake of my anxiety we'll say those were just napkin math figures for your example. @JD Martin now I'm curious if the person you were having this argument with was another moderator 🤔

Hypothetical - how are these tax calculations done?

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