§1245 Recapture Math on a 3-Year Flip

Full worked NPV on a 3-year STR flip with cost segregation: bonus depreciation forward, ordinary-rate recapture back, and the after-tax cash net.

§1245 Recapture Math on a 3-Year Flip

What you'll learn. A start-to-finish worked NPV on a $900,000 short-term rental purchased in 2026 and sold in 2029, with cost segregation reclassifying ~28% of the building basis. The walkthrough quantifies the year-1 deduction, the §1245 ordinary-income recapture at sale, the §1250 unrecaptured gain on the building shell, and the net present value at a 7% discount rate. This complements the §1245 hero article by showing exactly where the cash lands across the four years.

The fact pattern

• Property: lakefront short-term rental in Conroe, TX
• Acquired: April 2026, $900,000 (land $150,000, building $750,000)
• Acquisition costs (title, transfer, recording): $8,000 — capitalized into basis under Treas. Reg. §1.263(a)-2
• Engineering study: 5-year personal property $158,000, 15-year land improvements $52,000 (~28% of $758,000 building + capitalized basis)
• 100% bonus depreciation under OBBBA §70301
• Federal bracket: 35% ordinary; long-term cap gains 20% + 3.8% NIIT = 23.8%; §1250 unrecaptured gain 25%
• Sold: April 2029 for $1,025,000 (no improvements during hold)
• Discount rate for NPV: 7%

The numbers reflect the calculations our feasibility estimator performs in _compute_recapture_warning() when planned_disposition is set to 2-5yr.

Year 0 — purchase and depreciation setup

Depreciable basis after capitalizing settlement costs: $750,000 + $8,000 = $758,000. Allocations:

• 5-year personal property: $158,000
• 15-year land improvements: $52,000
• 27.5-year building (residential STR): $548,000

Year 1 deduction — 2026

Using bonus_rate_for_year(2026, 4) = 1.00 and the half-year convention (Q2 acquisition, no mid-quarter trigger):

• 5-year bonus: $158,000 × 100% = $158,000
• 15-year bonus: $52,000 × 100% = $52,000
• Building S/L mid-month, April acquisition: $548,000 / 27.5 × ((12.5 - 4) / 12) = $548,000 / 27.5 × 0.708 = ~$14,114
• Total year-1 deduction: ~$224,114
• Federal tax effect at 35% (assuming material participation under STR §469(c)(2) carve-out): ~$78,440

Years 2 and 3 — ordinary depreciation continues

5-year and 15-year buckets are fully bonused; remaining basis is zero, so MACRS is zero on those classes.

• Year 2 (2027) building: $548,000 / 27.5 = $19,927
• Year 3 (2028) building: $19,927
• Year 4 (2029, sale year): mid-month convention truncates the building deduction at the disposition month — April sale gives $19,927 × (3.5 / 12) = $5,812

Cumulative depreciation through April 2029: $14,114 + $19,927 + $19,927 + $5,812 = $59,780 on the building, plus $158,000 + $52,000 = $210,000 fully bonused on personal property and land improvements. Adjusted basis at sale: $758,000 - $59,780 - $210,000 = $488,220 (plus $150,000 land = $638,220 total adjusted basis).

Sale calculation — gross gain

Sale price $1,025,000. Allocate sale proceeds proportionally to original cost components (a common allocation method when the contract is silent — Treas. Reg. §1.1060-1 governs §1060 acquisitions but the same logic informs disposition allocation):

• Land: $150,000 / $908,000 × $1,025,000 = $169,328
• Building: $548,000 / $908,000 × $1,025,000 = $618,498
• 5-year property: $158,000 / $908,000 × $1,025,000 = $178,335
• 15-year property: $52,000 / $908,000 × $1,025,000 = $58,839

Total gain: $1,025,000 - $638,220 = $386,780.

§1245 recapture — the painful part

IRC §1245(a)(1) recaptures depreciation taken on §1245 property (the 5-year and 15-year buckets) as ordinary income, capped at the gain on each asset. Cumulative bonus + MACRS on those buckets was $210,000.

• 5-year property: original basis $158,000, depreciation $158,000, allocated sale proceeds $178,335. Gain on this asset is $178,335 - $0 = $178,335. Of that, $158,000 is §1245 ordinary recapture; the remaining $20,335 is capital gain.
• 15-year property: original basis $52,000, depreciation $52,000, allocated proceeds $58,839. §1245 ordinary recapture: $52,000. Remaining $6,839 capital.
• Total §1245 ordinary recapture: $210,000 at 35% = $73,500 in federal tax

§1250 unrecaptured gain — the building

IRC §1250 only recaptures depreciation in excess of straight-line, and 27.5-year residential is straight-line — so there's no §1250 recapture. But §1(h)(1)(E) imposes a 25% rate on "unrecaptured §1250 gain" equal to the lesser of accumulated depreciation or the gain. Building depreciation taken: $59,780. Building gain: $618,498 - $488,220 = $130,278. Unrecaptured §1250 gain: $59,780 × 25% = $14,945 federal tax.

The remaining building gain ($130,278 - $59,780 = $70,498) plus the residual capital portion of the personal-property gains ($20,335 + $6,839 = $27,174) — total $97,672 — is long-term capital gain at 23.8%: $23,246 federal tax.

Land gain: $169,328 - $150,000 = $19,328 long-term capital gain at 23.8%: $4,600 federal tax.

Total federal tax at sale

• §1245 ordinary recapture: $73,500
• §1250 unrecaptured gain at 25%: $14,945
• Long-term capital gain at 23.8%: $23,246 + $4,600 = $27,846
• Total: $116,291

If the same property had been depreciated straight-line only (no cost seg), accumulated depreciation through April 2029 would have been ~$76,500 — all on the 27.5-year building. §1250 unrecaptured gain at 25% on $76,500 = $19,125. The remaining gain would be straight long-term capital. The cost-seg path traded $158,000 + $52,000 = $210,000 of ordinary-rate recapture for $76,500 - $59,780 = $16,720 of additional §1250 unrecaptured gain — a roughly $34,000 cost on the back end ($73,500 - $14,945 - $25,500 ≈ $33,055).

NPV at 7%

| Year | Cash from tax effect | PV factor (7%) | PV | |---|---|---|---| | 2026 | +$78,440 (year-1 deduction × 35%) | 1.000 | +$78,440 | | 2027 | +$6,974 ($19,927 × 35%) | 0.935 | +$6,520 | | 2028 | +$6,974 | 0.873 | +$6,088 | | 2029 | +$2,034 - $116,291 | 0.816 | -$93,393 |

NPV of cost-seg path: -$2,345

The straight-line counterfactual NPV is roughly +$3,500 over the same period (smaller front-loaded deductions, smaller back-end recapture). Cost seg actually destroyed about $5,800 of NPV on this 3-year flip.

When the math does and doesn't work

The breakeven hold period for STR + cost-seg + 100% bonus on these inputs is roughly 5–6 years at a 7% discount rate. Below that, §1245 recapture eats the time-value-of-money advantage. Above that, the front-loaded deductions compound enough to outpace the recapture. This is exactly why our engine flags a recapture warning whenever planned_disposition is lt-2yr or 2-5yr — and why the §1031 carryover-basis sequencing walkthrough covers the alternative exit strategy.

Screen a 3-year STR flip with recapture modeled →

Sources

• IRC §1245(a)(1) — Recapture of depreciation as ordinary income
• IRC §1250 — Gain from disposition of certain depreciable realty
• IRC §1(h)(1)(E) — 25% rate on unrecaptured §1250 gain
• IRC §168(k) — Bonus depreciation as amended by OBBBA §70301
• Treas. Reg. §1.263(a)-2 — Capitalization of acquisition costs
• IRS Publication 544 — Sales and Other Dispositions of Assets
• IRS Form 4797 Instructions — Sales of Business Property

Disclaimer. This tutorial describes general federal tax concepts. TaxProtestTx (Nought Labs LLC) is a feasibility-screening tool, not tax advice or a cost segregation study. Calculator output cannot be relied on under Treasury Circular 230. Consult a qualified CPA, EA, or attorney before filing. Results are not guaranteed.