Selling a Short-Term Rental After Cost Segregation: What Taxes Could You Owe?

By Steve R. Madsen, CPA · Madsen and Company · September 2026

Quick Answer

When you sell a short-term rental after a cost segregation study, the tax depends on the gain allocated to each asset. Some gain may be ordinary income from depreciation recapture, some may be unrecaptured Section 1250 gain subject to a maximum 25% federal rate for individuals, and the remainder may receive Section 1231 treatment.

How much, and at what rate, depends on how the sale price is allocated across the property’s components. And the cash you walk away with after paying off the loan is not the same as the gain you are taxed on.

Because a study front-loads deductions, it also front-loads the recapture conversation. The right move is to model the after-tax exit before you list, not after you have an offer in hand.

Why a cost segregation study changes the sale, not just the purchase

A cost segregation study accelerates depreciation by reclassifying parts of a property into shorter-lived categories, which may lower current tax when those deductions are usable. It does not make depreciation free. Your adjusted basis, which is what your gain is measured against, is reduced by depreciation allowed or allowable, so it drops whether or not you actually claimed every dollar (IRS Publication 544). The faster you depreciate, the lower your basis at sale, and the larger the portion of your gain that traces back to depreciation.

Simply holding the property longer does not erase its depreciation history. Whether depreciation produces ordinary-income recapture when you sell still depends on the gain and tax classification of the assets sold. If you want the mechanics of the study itself, we cover them in Cost Segregation Explained and the STR-specific version in Is a Cost Segregation Study Worth It for Your STR?

How different assets are taxed when you sell

Cost segregation usually splits a building into more than one tax category, and the categories are not treated alike on sale. The asset classification matters when estimating the tax.

Section 1245 property

This category generally includes reclassified personal property such as certain appliances, furnishings and equipment. Gain on each Section 1245 asset is generally ordinary income up to the depreciation allowed or allowable on that asset. Depreciating an asset does not, by itself, mean its full depreciation will be recaptured: the amount also depends on the gain allocated to that asset when it is sold.

Section 1250 property

This category generally includes the building and certain land improvements. For a building depreciated using the required straight-line method and held longer than one year, depreciation generally does not become ordinary-income recapture under Section 1250. Instead, the portion of eligible gain attributable to that depreciation may be unrecaptured Section 1250 gain, subject to a maximum 25% federal rate for individuals. Accelerated depreciation on certain Section 1250 assets can produce ordinary-income recapture. Any remaining gain is evaluated under the applicable Section 1231 rules.

For example, if furnishings were fully depreciated but only $2,000 of the sale price is reasonably allocated to them, their Section 1245 ordinary gain may be $2,000, not the full amount previously deducted for those furnishings. The allocation must be supportable; a seller cannot assign an arbitrary value to reduce recapture.

An asset’s recovery period alone does not determine whether it is Section 1245 or Section 1250 property. Some shorter-lived land improvements are Section 1250 property. The sale price and applicable selling costs must be reasonably allocated among land, the building and the other assets sold. That allocation, the depreciation history and the gain on each asset determine the tax result. The 25% rate is a maximum for qualifying unrecaptured Section 1250 gain; it is not a flat rate on the sale.

Proceeds are not the same as taxable gain

A frequent surprise at closing: paying off the mortgage reduces the cash in your pocket, but it does not reduce your taxable gain. Gain is the sale price, minus selling costs, minus your adjusted basis. The loan balance never enters that formula. It is entirely possible to owe tax on a healthy gain while walking away with modest cash, because most of the proceeds went to the lender. Knowing that number in advance is the difference between a planned exit and an April surprise.

What happens to suspended passive losses when you sell

If you have suspended passive losses from this activity, include them in the sale analysis. When you dispose of your entire interest in a passive or former passive activity in a transaction that recognizes all gain or loss to an unrelated party, those losses are generally released in the year of disposition. Whether selling one property disposes of the entire activity depends on how your activities were treated, including any grouping. An installment sale or tax-deferred exchange can change the timing of the loss release. Also, passive-loss carryforwards, excess business losses and net operating losses follow different rules. For background, see Can Short-Term Rental Losses Offset W-2 Income?.

Model the exit before you list

Because the study accelerated your deductions, the sale is where the trade-off is settled. Before you commit to selling, the numbers worth running are your adjusted basis after all depreciation, the allocation of the sale price across the components, ordinary-income recapture under Sections 1245 and 1250, any remaining unrecaptured Section 1250 gain, any suspended passive losses that would release, and the actual cash after the loan payoff. That is a modeling exercise, not a guess, and it is far better done before a listing than after an offer.

The estimate should also consider your holding period, any prior Section 1231 losses, applicable state income tax and whether the net investment income tax applies.

If the after-tax number changes your decision, review any potential Section 1031 exchange or installment sale before signing a sale agreement. Section 1031 generally applies to qualifying real property, not the furnishings and other personal property commonly identified in a cost segregation study. An exchange can still produce currently taxable gain or depreciation recapture. With an installment sale, Section 1245 or Section 1250 ordinary-income recapture is generally reported in the year of sale, even if you have not yet received payment. See IRS Publication 544.

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