Does depreciation recapture trigger at refinance or only at sale?

What recapture means for refi planning and exit timing

This page is sponsor-POV process commentary, not tax or legal advice. Bring a CPA and tax counsel onto every transaction before relying on any of the mechanics described below.

§1250 recapture applies to depreciation taken on real property and is taxed at a maximum 25% rate (the so-called unrecaptured §1250 gain). §1245 recapture applies to personal property and 5/7/15-year property reclassified by cost seg, and is taxed at ordinary rates. Both apply at a sale or other taxable disposition. A gift does not trigger section 1245 or 1250 recapture. The recapture potential carries to the donee.

Refinance: a loan is not a disposition. The IRS does not treat the refi as a realization event because the borrower owes the proceeds back. Cash-out refi proceeds distributed to LPs are tax-free at distribution but the proceeds remain debt, when the property is eventually sold, the gain calculation is sale price minus adjusted basis, and the depreciation recapture is calculated on the original depreciation taken regardless of how the cash flowed in the interim.

Negative basis: aggressive cost seg and bonus depreciation can drive an investor's basis in the partnership interest below zero. Subsequent distributions in excess of basis are treated as gain. Refinance proceeds count as debt (not income), but the basis tracking matters for the eventual sale or for additional contributions.

Practical sponsor planning: model the recapture exposure at the original underwriting. Sponsors planning a hold past the typical 5- to 7-year syndication horizon should illustrate the recapture math in the LP marketing package; sponsors planning a 1031 exchange at exit should make the §1031 mechanics explicit because the deferral defers recapture as well as gain.