Not all deferred gain is taxed the same way, and the difference between the two rates can be significant. The type of property that generated the depreciation determines the rate — and a Section 1031 Exchange defers both kinds in their entirety.
Two Types of Property, Two Different Tax Rates
When you hold investment real estate, you deduct depreciation each year. That deduction lowers your taxable income while you own the property — and lowers your basis dollar for dollar. When you sell, the IRS takes some of that benefit back. The portion of your gain that came from depreciation you claimed is “recaptured” and taxed at a higher rate than the rest of your capital gain.
The rate depends entirely on what kind of property produced the depreciation.
On the building itself — Section 1250 property — recapture is taxed at a maximum of 25%. That cap applies regardless of your ordinary income bracket.
On personal property such as furniture, fixtures, and equipment — Section 1245 property, also called FF&E — the recapture is taxed as ordinary income, up to 37%. That’s nearly one and a half times the rate that applies to the building. The only ceiling is the depreciation you actually took; you can’t be recaptured for more than you claimed.
So if you’ve owned a furnished rental for a decade, you’re looking at two separate recapture calculations when you sell: one at up to 25% on the building’s accumulated depreciation, and one at up to 37% on the beds, appliances, and equipment you’ve been writing off.
What the Tax Cuts and Jobs Act Changed
Before 2018, personal property rode along inside a Section 1031 Exchange without distinction. Since January 1, 2018, the exchange applies only to real property. The FF&E is carved out — its sale is treated as a separate transaction, and any tax owed on the personal property side is due in the year of sale, not deferred.
That split means every deal now has two parts. The portion of your sales price attributable to the FF&E is a separate sale from the real estate sale. The recapture on the personal property at ordinary-income rates is no longer automatically deferred.
Bonus Depreciation as an Offset
There is a practical offset available on the personal property side. Bonus Depreciation — now 100% and permanent for property placed in service after January 19, 2025 under the One Big Beautiful Bill Act — lets you write off the full cost of qualifying short-lived assets in year one rather than over several years. It applies to furniture, fixtures, equipment, and certain improvements, not to the building itself.
Critically, it applies to used property as well, as long as the property is new to you, purchased from an unrelated party, and your basis is what you paid. This means the FF&E in a Replacement Property you acquire can generate an immediate deduction that offsets the recapture triggered on the FF&E you sold — reducing what you owe in that year, sometimes to little or nothing.
The Exchange Defers Both Kinds of Recapture
On the real estate side, a Section 1031 Exchange defers the recapture right along with the rest of the gain. The 25% recapture on the building, the underlying capital gain, even the 3.8% Net Investment Income Tax that applies to higher earners — all of it stays deferred as long as you stay in the exchange. Gain you don’t recognize isn’t income yet, so there is nothing for any of these taxes to attach to.
Keep exchanging, and at death your heirs take the property at stepped-up basis — the accumulated recapture and deferred gain disappear entirely.
The exchange doesn’t eliminate the recapture liability; it carries it forward into the Replacement Property’s lower basis. But deferral has real value — and indefinite deferral, rolled from exchange to exchange, can become permanent.