Part 2 of our recapture series. Educational only — not tax advice.
One Sale Price, Many Tax Outcomes
Because recapture is tested at the component level, a single property-wide gain number is rarely enough. The way you allocate the sale price across land, the building shell, and the short-life cost-segregated assets directly determines how much gain lands in the ordinary, unrecaptured §1250, and capital layers from Part 1. Allocation is not an afterthought — it is the lever.
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Method 1 — Appraisal-Based Allocation
The strongest support is a contemporaneous appraisal or valuation workpaper that allocates total value among land, building shell, site improvements, and personal-property-like components. This is especially useful in larger transactions or where the cost-seg classifications are material to the expected character of the gain.
Method 2 — Relative Fair-Market-Value Allocation
Where a separate appraisal is not available, proceeds can be allocated by relative fair market value across identifiable components, using engineering support, replacement-cost approaches, or market-derived allocation keys. The principle: each component's gain or loss should be tested against its own adjusted basis.
Method 3 — Residual Allocation After a Land Carve-Out
A practical middle ground: carve out land first (it is never depreciable, so its gain is never recapture), then spread the remaining proceeds across the depreciable components using a relative-value matrix derived from the cost segregation schedule, prior appraisals, or a valuation memo. This is often the minimum viable structure for investor reporting and disposition underwriting.
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A Control Table for the Allocation
Whatever method you use, work through the same four steps and watch the same four risks:
- Land carve-out — separates non-depreciable gain. Risk: overstating depreciation-related gain by under-allocating to land.
- Building shell — identifies the straight-line §1250 base. Risk: misstating unrecaptured §1250 gain.
- §1245 components — allocates proceeds to short-life assets. Risk: over- or understating ordinary recapture.
- Retired / partial assets — separates disposed portions from the continuing asset. Risk: duplicated depreciation or a missed write-off (the subject of Part 3).
The Practical Takeaway
Keep the cost segregation schedule and any appraisal support with the property file for the full hold. When the sale comes, that documentation is what lets your advisor allocate the proceeds rationally and characterize the gain correctly — instead of defaulting to a blended estimate that may overstate the ordinary layer. ClickDrag retains your component schedule for exactly this reason — a study started today is also the exit file you will want in year 7. Coordinate the final allocation with your tax advisor.
