FIRPTA and Cost Segregation Recapture on a Vacation Rental Sale: The Accelerated Depreciation Comes Back at Ordinary Rates

Cost segregation is a depreciation strategy: an engineering study reclassifies parts of a building (fixtures, appliances, flooring, landscaping, site improvements) from 27.5-year residential property to 5-, 7-, and 15-year property, and bonus depreciation lets much of it be deducted in the first year. For a Canadian who has done this on a US vacation rental, the strategy works during ownership and reverses on sale: the accelerated depreciation on personal property is recaptured as ordinary income, the building's depreciation is recaptured at up to 25%, FIRPTA withholds 15% of the gross price regardless, and Canada taxes its own version of the gain. The seller who did the study has a larger recapture bill than one who did not.

Key takeaways

• Cost segregation reclassifies components of a rental building into shorter recovery classes (5, 7, and 15 years); bonus depreciation (100% for property placed in service after January 19, 2025, under the 2025 law; 40% or 60% for 2024 and 2025 placements under the phase-down) deducts most of the reclassified cost in the first year.
• Recapture on sale: gain attributable to depreciation on section 1245 property (the 5- and 7-year components) is ordinary income at up to 37%; gain attributable to depreciation on section 1250 property (the building and 15-year land improvements) is unrecaptured section 1250 gain at up to 25%; the remaining gain is long-term capital gain at 15% or 20%.
• FIRPTA: the buyer withholds 15% of the gross sale price; Form 8288-B before closing can reduce it to the expected tax; the seller files a 1040-NR reporting the sale and recovers the excess.
• Canada: the gain is computed in Canadian dollars on the T1; if capital cost allowance was claimed on the T776, it is recaptured as income; the US tax is a foreign tax credit. Canada does not distinguish the recapture classes.
• Net effect: cost segregation defers tax during ownership at the cost of a higher rate on the recaptured portion at sale; for a short holding period it can produce a net cost; for a long one, the deferral usually wins.

How cost segregation works

A residential rental building is depreciated over 27.5 years on a straight-line basis. A cost segregation study identifies components that qualify as personal property or land improvements: appliances, carpeting, cabinetry, decorative fixtures, certain electrical and plumbing serving specific equipment (5- or 7-year); paving, fencing, landscaping, pools (15-year). Those components are depreciated over their shorter lives, and bonus depreciation allows an immediate deduction of a large percentage of their cost in the year placed in service. A $700,000 condo might have $120,000 reclassified; with 100% bonus depreciation, $120,000 is deducted in year one instead of about $4,400.

For a Canadian owner under the section 871(d) election, the first-year deduction produces a rental loss, which offsets rental income in that year and carries forward as a passive loss (a non-resident's rental losses are suspended under the passive activity rules and released on sale). The Canadian return is unaffected: Canada allows only its own CCA (4% declining balance on the building, optional), so the US loss has no Canadian counterpart, and the Canadian tax on the rent is unchanged. The foreign tax credit in Canada is smaller because the US tax is smaller.

Recapture on sale

The sale price is allocated among the asset classes. Gain on section 1245 property (the 5- and 7-year components) up to the depreciation taken is recaptured as ordinary income at the seller's marginal rate, up to 37%; a component fully depreciated and sold for any value produces ordinary income equal to the lesser of the gain and the depreciation. Gain on section 1250 property (the building) up to the straight-line depreciation taken is unrecaptured section 1250 gain at a maximum of 25%. The rest is long-term capital gain at 0%, 15%, or 20%. A Canadian seller pays these rates on a 1040-NR as effectively connected gain; the suspended passive losses are released in the sale year and offset the ordinary income.

The 15-year land improvements are section 1250 property in most cases (25% recapture), though bonus depreciation on them can produce section 1245-type recapture under specific rules; the study's classification matters.

FIRPTA

FIRPTA withholding is 15% of the gross price, unaffected by the depreciation history. On a $900,000 sale, $135,000 is withheld. Form 8288-B, filed before closing with the computation of the actual tax (including the recapture), asks the IRS for a withholding certificate authorizing a lower amount; the closing agent holds the withholding in escrow pending the certificate. The seller files a 1040-NR for the year reporting the sale on Form 4797 (recapture) and Schedule D (capital gain), with the withholding as a payment, and recovers the excess. State income tax applies in states that have one; Florida has none.

Canada

The T1 reports the disposition in Canadian dollars: proceeds at the sale-date rate less the adjusted cost base at the purchase-date rate less selling costs; half the gain is taxable. If CCA was claimed on the T776 in earlier years, the recaptured CCA is fully taxable as rental income. Canada does not follow the US classes; the US tax paid (federal and state, including the recapture tax) is a foreign tax credit on Form T2209 limited to the Canadian tax on the US-source income. The currency movement since purchase can make the Canadian gain larger or smaller than the US gain.

Whether it was worth it

Cost segregation defers tax; the deferred amount comes back at recapture rates that can exceed the rate at which it was deducted (a deduction against rental income taxed at graduated rates, recaptured as ordinary income at the top rate in a high-gain sale year). Over a long holding period the time value of the deferral and the offset against rental income usually outweigh the recapture; over a short one, the seller can pay more total tax than without the study. For a Canadian, the Canadian side is indifferent to the US timing, so the analysis is a US one. The study's fee ($5,000 to $15,000 for a residential property) is also deductible.

Worked example

A Vancouver couple bought a $800,000 Fort Lauderdale condo in 2024, commissioned a cost segregation study reclassifying $140,000 into 5- and 15-year property, and took $84,000 of bonus depreciation (60%) plus regular depreciation. They sell in 2026 for $950,000 after $110,000 of total depreciation ($70,000 on section 1245 components, $40,000 on the building).

• US. Gain $150,000 plus depreciation recaptured. Section 1245 recapture: $70,000 as ordinary income (up to 37%); unrecaptured 1250: $40,000 at 25%; capital gain: $150,000 at 15% or 20%. Suspended passive losses from the bonus year offset the ordinary income. Roughly $60,000 of federal tax. FIRPTA withholds $142,500; Form 8288-B reduces it to about $60,000.
• Canada. Proceeds and ACB in CAD (the loonie fell over the period, enlarging the gain); no CCA was claimed, so no Canadian recapture; half the CAD gain taxable at BC rates; the $60,000 USD of US tax is a credit.
• Without the study. About $30,000 of 1250 recapture at 25% and the same capital gain; roughly $45,000 of federal tax at sale, but $84,000 less depreciation deducted in 2023, which had offset rental income taxed at graduated rates. Over three years, the study roughly broke even; over ten it would have won.

Official sources

"The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate." — Internal Revenue Service, Topic No. 409, Capital Gains and Losses, https://www.irs.gov/taxtopics/tc409

"Cost Segregation Studies are used to classify taxpayer assets into shorter recovery periods to accelerate the depreciation deductions for the assets." — Internal Revenue Service, Cost Segregation Audit Techniques Guide, Publication 5653, https://www.irs.gov/pub/irs-pdf/p5653.pdf

"The disposition of a U.S. real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding." — Internal Revenue Service, FIRPTA Withholding, https://www.irs.gov/individuals/international-taxpayers/firpta-withholding

"You may be able to claim the foreign tax credit if you paid foreign income or profit taxes on income you earned outside Canada and reported on your Canadian tax return." "Complete Form T2209, Federal Foreign Tax Credits, to calculate your federal foreign tax credits." — Canada Revenue Agency, Federal foreign tax credit, https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-40500-federal-foreign-tax-credit.html

Practitioner note

Cost segregation on a Canadian's US rental is a US timing play with a Canadian side that does not move: Canada taxes the rent and the gain on its own rules regardless. The recapture at sale is the part sellers forget, and the FIRPTA 8288-B is the form that keeps 15% of the price out of escrow for a year. We compute the recapture by class before the listing and file the 8288-B with it.

See also: For the full sequence of a Canadian move to Florida, see the Canada-to-Florida tax guide, and browse every cross-border tax topic guide, organized by situation.

Next step

Fairlight prepares the pre-sale recapture computation, the Form 8288-B application, the 1040-NR reporting the sale by asset class, and the Canadian return with the foreign tax credit. See cross-border pricing or book a call.