Depreciation Recapture When a Syndicated Building Sells
When a syndicated apartment building sells, the depreciation deductions you received during the hold can come back as tax. The part of the gain that matches earlier depreciation is treated differently from ordinary capital gain, and some items from a cost segregation study can be taxed as ordinary income. This post explains the buckets in plain language with a hypothetical example. It is general education, not tax advice. Talk to your tax adviser early, because the choices that matter are made before the sale.
This post is part of our guide to real estate syndication. It builds on taxes for syndication investors and cost segregation. Tax rules are as of October 2026 and change.
What depreciation is
The IRS lets owners deduct the cost of a rental building over time, because buildings wear out. Residential rental property is generally depreciated over 27.5 years using a straight-line method (the same deduction each year). Land is not depreciable. Your share of the company's depreciation reaches you on your Schedule K-1 and can reduce your taxable income from the investment. See the K-1 guide and IRS Publication 527, which covers residential rental property.
A cost segregation study breaks the property into parts, such as appliances and flooring, that depreciate faster than the building shell. It speeds up deductions. It also shapes recapture. See cost segregation.
Depreciation is a tax item. It is not cash. A deal can show a paper loss for tax and still pay cash distributions, or the reverse. Depreciation also does not erase the risk that you lose money on the investment.
Basis in plain words
Your basis is roughly what you have invested for tax purposes. It starts with the cash you put in. Each year it goes up by your share of income and down by your share of losses (including depreciation) and by distributions you take. Your K-1 and your own records track it.
Why it matters: your gain on a sale is generally the amount you receive minus your basis. Because depreciation lowers basis, it raises your gain by the same amount. That is the reason for recapture. You had the deduction earlier, and the sale brings it back into the calculation.
Basis rules for partnership interests are technical, and the company's basis and your outside basis can differ. Your tax adviser should keep both in view.
The gain buckets
When the company sells the building, the gain is calculated at the company level and passed to you on your K-1, with its character (what type of gain it is). Broadly, three buckets can be involved. See IRS Publication 544, Sales and Other Dispositions of Assets, and the instructions for Form 4797.
1. Unrecaptured section 1250 gain. For real property, such as the building shell of an apartment, the part of the gain that equals prior straight-line depreciation is called unrecaptured section 1250 gain. For individuals it is taxed at ordinary rates, up to a maximum rate set by law (the IRS Schedule D instructions state the current maximum). It is not taxed as ordinary income in every case, and it is not taxed at the lowest long-term capital gain rates either. See section 1250.
2. Ordinary income recapture on personal property. Items identified in a cost segregation study as personal property (for example, some appliances or fixtures) are generally section 1245 property. On sale, gain up to the depreciation previously taken is recaptured as ordinary income. See section 1245. This is why cost segregation can create a larger recapture piece.
3. Capital gain. Any gain above the original cost, the appreciation, is generally long-term capital gain if the holding period is more than a year. It is usually taxed at the long-term capital gain rates, which are lower than ordinary rates for most people.
Other taxes, such as the net investment income tax and state taxes, may also apply. Whether they do depends on you.
A hypothetical walk-through
This example is hypothetical, with round numbers, for illustration only. It is not a forecast, and it is not a sign of what any deal will do. Tax rates are not applied, because they depend on your situation and change. Only the split of the gain is shown.
Suppose a company buys a building for $10,000,000. Assume $2,000,000 is land and $8,000,000 is building and improvements. Suppose later it sells for $12,000,000, and the company has taken $1,500,000 of depreciation in total, of which $300,000 relates to items treated as personal property and $1,200,000 to the building.
| Step | Amount |
|---|---|
| Original cost | $10,000,000 |
| Less depreciation taken | $1,500,000 |
| Adjusted basis at sale | $8,500,000 |
| Sale price (ignoring selling costs) | $12,000,000 |
| Total gain | $3,500,000 |
How the $3,500,000 gain is split:
| Bucket | Amount | Reason |
|---|---|---|
| Ordinary income recapture (section 1245 items) | $300,000 | Gain up to depreciation on personal property |
| Unrecaptured section 1250 gain | $1,200,000 | Depreciation taken on the building |
| Capital gain | $2,000,000 | The remaining gain, from appreciation |
| Total | $3,500,000 |
Only the split is meaningful here. Without depreciation the adjusted basis would have been $10,000,000 and the total gain $2,000,000. Depreciation raised the gain by $1,500,000, and that amount sits in the first two buckets. The investor shares in the company's gain in proportion to their ownership, subject to the waterfall in the operating agreement. See the waterfall and try the profit split tool for how sale proceeds are shared, which is a separate question from tax. Selling costs, loan payoff, the sponsor's share and prior distributions all change what lands in your account, and your tax bill is not tied to the cash you receive.
One point many investors miss: the tax on a sale is based on gain, not cash. You can owe tax on a sale for which the cash comes after loan payoff and fees. Plan for the tax from your own funds.
Suspended passive losses
Rental activity is generally passive. Passive losses can usually offset only passive income, and any excess is "suspended" and carried forward. See IRS Publication 925 and section 469. When you dispose of your entire interest in a fully taxable transaction, suspended losses from that activity are generally released and can offset other income. Because of this, the year of sale can look different from the years before it. Whether your losses were suspended, and how much, depends on your own income and other activities, which your CPA will know. Selling only part of your interest does not release them in the same way.
Options people ask about
1031 exchange. A like-kind exchange can defer tax on real property gain when proceeds are reinvested in other qualifying real property under strict timelines. When a partnership sells, the exchange is generally at the company level, so individual investors cannot exchange on their own. Some structures let investors exchange separately, and some deals offer a choice to cash out or roll into another property. See DST vs. syndication and 1031.
Delaware statutory trusts (DSTs). Some investors reinvest sale proceeds into a DST interest to continue the deferral. These are separate securities with their own risks, fees and limits.
Holding the interest. Estate rules can change basis at death. This is a topic for your estate planner.
Installment sales and other methods. Spread gain over several years in some cases. Your adviser will know whether they apply.
None of these is a promise of lower tax. Each has conditions, and each comes with costs and risks.
What to ask the sponsor and your CPA
Ask the sponsor:
- Was a cost segregation study done, and how much of the depreciation relates to personal property?
- What does the plan say about the timing of a sale and the likely tax character of the gain?
- Does the operating agreement provide for tax distributions at sale?
- When will the K-1 for the year of sale be ready? See K-1 timing.
- Is there an option to roll into another deal at sale?
Ask your CPA:
- What is my basis, and how will the sale change it?
- Do I have suspended passive losses?
- What is the likely split of the gain, and how will it affect my other income?
- What state tax applies?
- Should I plan for estimated tax payments in the sale year?
How DoorRaise fits in
DoorRaise handles the K-1s for each deal's company. The character of gain at sale is determined by the company's records and the tax law, not by DoorRaise, and we do not give tax advice. The tax outcome of any sale is not predictable here.
Raise your apartment deal from the people who already follow you.
DoorRaise is built for apartment buildings with 5 or more units: one link for the deal, escrow until closing and a standard fee card.
If you are a sponsor, see how DoorRaise works, or create your sponsor page. Investors can read about investor reporting.
FAQ
What is depreciation recapture?
It is the tax treatment of the part of a gain that equals depreciation you or the company deducted earlier. For apartment buildings it usually means unrecaptured section 1250 gain, plus ordinary income recapture on some personal property.
Is depreciation recapture taxed as ordinary income?
For the building shell, unrecaptured section 1250 gain has its own maximum rate rather than being taxed as ordinary income. Items treated as personal property can be recaptured as ordinary income. Your adviser can tell you which applies.
Do I owe tax if I did not receive the cash?
Gain is based on the company's sale and passes to you on the K-1. Your tax can be due even when the cash is used for loan payoff, fees or reserves. Plan for it.
Can I avoid recapture with a 1031 exchange?
An exchange can defer tax in some cases. It is strict, and for a syndication it is usually decided at the company level. It is not avoidance, and the deferred gain is tracked into the new property.
What happens to suspended passive losses when the building sells?
When you dispose of your whole interest in a fully taxable transaction, they are generally released and can offset other income. Your CPA can confirm what applies to you.
Does cost segregation make recapture worse?
It front-loads deductions and can increase the part of the gain taxed as ordinary recapture. Whether the trade is worth it depends on your situation. It does not change whether the investment makes or loses money.
Sources
- IRS Publication 544: Sales and Other Dispositions of Assets
- IRS Instructions for Form 4797: Sales of Business Property
- IRS Publication 527: Residential Rental Property
- IRS Publication 925: Passive Activity and At-Risk Rules
- 26 U.S.C. 1250: Gain from dispositions of certain depreciable realty (Cornell LII)
- 26 U.S.C. 1245: Gain from dispositions of certain depreciable property (Cornell LII)
- 26 U.S.C. 469: Passive activity losses and credits limited (Cornell LII)
The example is hypothetical, with round numbers, for illustration only. It is not a projection or advice. This article is general tax information as of October 2026, not tax, legal or investment advice. Talk to your CPA or tax adviser. Every investment can lose money. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.