Tax Strategy · Article
Depreciation recapture: cash vs. installment sale in Kansas
Section 1250 recapture hits Kansas multifamily sellers in year one, cash or installment. On a $900K sale with $186K of accumulated depreciation, expect about $46,500 in federal recapture tax no matter how you structure the proceeds.
Key takeaways
What this article covers
- Section 1250 recapture is taxed at 25% federal and lands in full in year one, even on a seller-financed installment note.
- IRC 453 lets you spread capital gains across installment years, but it does not defer or spread the recapture portion.
- On a Wichita 16-unit with $186,000 of accumulated depreciation, the seller owes roughly $46,500 in recapture tax in year one.
- If year-one installment receipts are smaller than the recapture tax due, you owe the IRS before you collect enough cash to cover it.
- Knowing your adjusted basis and accumulated depreciation before signing is the key tax step for any Kansas multifamily seller.
I get this question more than almost any other from Kansas sellers: "If I carry back a note instead of taking cash, do I avoid the big tax hit in year one?"
The short answer is: not entirely, and the part you cannot defer is exactly the part that blindsides most sellers.
This post walks through depreciation recapture on a Kansas multifamily sale, why it lands in year one regardless of how you structure the deal, and how to plan for it before you sign anything.
This is illustrative math, not tax advice. Talk to your CPA before structuring any sale.
The setup: a Wichita 16-unit, held since 2008
These numbers are illustrative, based on the kind of Wichita 5-to-50-unit properties we underwrite. The mechanics are real.
The property:
- 16 units, 1972 vintage, College Hill submarket, Wichita, KS
- Seller has held it since 2008. Original cost basis approximately $400,000
- Land allocated at $80,000. Building at $320,000
- Current rents averaging $725 per door
- No mortgage, clear title
We underwrote the Wichita 16-unit in this walkthrough at $900,000, and the recapture numbers here are representative of what we see on comparable long-hold Kansas B/C properties.
What is depreciation recapture?
Depreciation. When you own rental real estate, the IRS lets you deduct the cost of the building over 27.5 years. On a $320,000 building, that is roughly $11,636 per year. Over 16 years (2008 through 2024), the seller in this example has taken about $186,000 in depreciation deductions against ordinary income.
Unrecaptured Section 1250 gain. When you sell, the IRS recaptures the tax benefit from those deductions. The portion of your gain attributable to prior depreciation is taxed at a federal maximum of 25%, which is higher than the long-term capital gains rate that applies to the rest of your gain. It is reported on IRS Form 4797.
The rule that surprises sellers. Recapture is recognized in the year of sale. Not over time. Not spread across installments. All in year one.
According to IRS Publication 544, unrecaptured Section 1250 gain must be reported in full in the tax year the property changes hands, regardless of when the proceeds are received.
Does an installment sale spread the recapture?
This is the question that generates the most confusion, and the answer is clear: installment treatment does not defer the recapture portion.
How IRC 453 works. The installment method under Internal Revenue Code Section 453 lets a seller spread gain recognition across the years they receive principal payments on a seller-financed note. For a large capital gain, this can meaningfully reduce the tax impact by keeping the seller out of the top bracket in any single year.
The recapture exclusion. According to IRS Publication 537, depreciation recapture under Section 1250 is explicitly excluded from installment treatment. It must be reported in full in the year of sale.
In plain terms for the Wichita 16-unit example:
- Capital gain of $500,000: can be spread across the installment note term
- Recapture of $186,000: recognized in full in year one, no spreading, no deferral possible
If the seller in this example takes a seller-financed note with 10% down ($90,000 at close), they receive $90,000 in cash on day one but owe approximately $46,500 in recapture tax by April 15. That is more than half of the down payment, before state taxes.
Path 1: cash sale at $900,000
Here is the full gain and tax breakdown on a straight cash close. These are illustrative numbers based on the property setup above.
| Line | Amount |
|---|---|
| Original purchase price | $400,000 |
| Accumulated depreciation (16 years) | ($186,000) |
| Adjusted basis | $214,000 |
| Sale price | $900,000 |
| Total gain | $686,000 |
How the $686,000 gain splits and what it costs:
| Gain type | Amount | Federal rate | Federal tax |
|---|---|---|---|
| Unrecaptured Section 1250 (recapture) | $186,000 | 25% | $46,500 |
| Long-term capital gain | $500,000 | 20% | $100,000 |
| Net investment income tax (MAGI-dependent) | $500,000 | 3.8% | $19,000 |
| Total federal tax (illustrative) | $165,500 |
Net to seller after federal tax on a cash close: approximately $734,500.
Kansas taxes capital gains as ordinary income. See the Kansas Department of Revenue for current brackets; state tax is additional on top of the federal figures above.
Path 2: seller-financed installment note
Same $900,000 sale. The seller takes 10% down ($90,000) and carries a 10-year note at 7% on the $810,000 balance.
Year-one cash received (illustrative):
- Down payment at closing: $90,000
- Year-1 principal receipts: approximately $36,000
- Year-1 interest income: approximately $56,700
- Total cash in hand year 1: roughly $182,700
Year-one taxes owed (illustrative):
| Tax item | Year-1 amount |
|---|---|
| Recapture tax (all in year one) | $46,500 |
| Capital gain tax on year-1 principal allocation | approximately $13,000 |
| Ordinary income tax on interest received | bracket-dependent |
| Total year-1 tax (illustrative) | $59,500+ |
Net cash after year-1 taxes: approximately $123,200 in hand, before interest income tax and before Kansas state tax.
The installment structure does defer most of the $100,000 capital gain tax across 10 years, which reduces bracket pressure year over year. The $46,500 recapture, however, lands in full regardless of the note structure.
For more on how the full installment note math plays out across a 10-year term, see the seller-financing walkthrough for this same Wichita 16-unit.
What are the risks if you do not plan for this?
Three to be direct about.
Cash-flow mismatch. If you take a low down payment and the recapture tax exceeds your year-one cash receipts, you owe the IRS before you have collected enough to pay. On this example, the seller receives $90,000 at close and owes $46,500 in recapture tax. Add state income tax and closing costs and the margin shrinks fast. This is manageable with planning. It becomes a problem when a seller spends the proceeds before April 15.
Understated or missing depreciation records. Many sellers who have held a property for 15-plus years have inconsistent depreciation histories across accountants and tax software versions. The IRS recaptures the depreciation you were allowed to claim, not just the amount you actually reported. If your records are incomplete, the true recapture liability at sale may be larger than your current returns suggest. Your accountant needs to reconstruct the full depreciation schedule before you can price the deal accurately.
Estimated tax payment timing. Sellers who close in Q1 may not owe estimated taxes until April 15, which allows time to plan. Sellers who close in Q3 or Q4 may owe estimated payments in September and January. Work out the payment schedule with your CPA before signing the purchase agreement.
When does the recapture math change?
Three situations shift the calculation.
1031 exchange. Rolling proceeds into a like-kind replacement property through a qualified intermediary defers both the capital gain and the recapture. Neither is eliminated; they follow your adjusted basis into the next property. For sellers who want to stay invested in real estate, this is often the right path. The intermediary must be identified before the sale closes, and strict 45-day and 180-day timelines apply.
Qualified opportunity zone investment. Rolling the capital gain portion (not the recapture) into a QOZ fund can defer and partially reduce the capital gain tax. The $46,500 recapture still lands in year one regardless. This is a narrow planning tool and requires a CPA who knows the QOZ rules in detail.
Basis additions from capital improvements. If you capitalized a roof replacement, HVAC upgrade, or other improvements over the years, those additions have their own cost basis and depreciation schedules. A full reconstruction of all basis additions can reduce total gain. A cost segregation study may also clarify what was depreciated at accelerated rates and what that means for recapture.
When does selling with a note still make sense for a Kansas seller?
It is a good fit when:
- The capital gain portion is large enough that spreading it across years meaningfully reduces your bracket impact in each year
- You do not need all the proceeds immediately and have other liquidity to cover the year-one recapture obligation
- The recapture is a smaller share of the total gain (shorter hold, smaller building basis relative to land)
- You and your CPA have already run the year-one tax cash-flow scenario before signing the purchase agreement
It is the wrong fit when:
- The year-one recapture tax is close to or larger than your year-one down payment and installment receipts combined, and you have no other liquidity
- You need all the proceeds at close for a 1031 exchange, estate distribution, or debt payoff
- Your accumulated depreciation is unknown or unreconciled, making the true recapture liability unclear
The Kallpa Properties approach on tax discussions
When we talk through a Wichita or Kansas sale, we ask about adjusted basis and accumulated depreciation before we discuss price. It takes about 15 minutes with the seller's most recent Schedule E. That conversation determines whether recapture is a planning issue or a deal-structure issue.
If the recapture is manageable relative to the deal structure, a seller-financed close often works for both sides. If the year-one tax-to-cash mismatch is severe, a higher down payment, a different installment structure, or a cash close may serve the seller better.
To talk through how the numbers look on your specific Kansas property, start with the seller page or reach us through the Wichita page. We will run through the basis math with you before you commit to any structure.
The seller-financing pillar page has more context on the owner-carry structures we use and how recapture interacts with each one.
Frequently asked
Frequently asked questions
-
Does depreciation recapture apply if I never claimed depreciation on my taxes?
Yes. The IRS requires recapture on depreciation you were allowed to take, not just what you actually claimed. If you under-depreciated or skipped deductions across tax years, you still owe recapture on the full allowed amount at sale. This is one of the most common surprises we see on long-hold Kansas properties. -
Can a 1031 exchange defer depreciation recapture?
Yes. A properly structured 1031 exchange defers both capital gain and depreciation recapture by rolling your adjusted basis into the replacement property. The recapture is not eliminated, just deferred until you sell the replacement. A qualified intermediary must be in place before the sale closes. -
What is the difference between Section 1250 recapture and long-term capital gain?
Section 1250 recapture covers the portion of your gain attributable to depreciation taken on real property. It is taxed at a maximum federal rate of 25%. Long-term capital gains are taxed at 15% or 20% depending on your income. Both are calculated separately on IRS Form 4797 and Schedule D. -
Does recapture apply to the land portion of my property?
No. Land cannot be depreciated, so there is no recapture on the land value. Only the building and qualifying improvements are subject to depreciation and recapture. Your accountant will determine the land allocation from your original purchase records or appraisal. -
What if my multifamily property is held in an LLC?
The recapture rules are the same regardless of entity structure. A single-member or multi-member LLC passes the recapture through to the members on their individual returns. Only a C-corp faces different treatment, and C-corps are rarely used for long-term multifamily holds.
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