Depreciation Recapture: § 1245, § 1250, and Unrecaptured § 1250

Recapture under § 1245 and § 1250 recharacterizes a portion of gain on a sale of depreciable property from capital gain to ordinary income. The unrecaptured § 1250 rate of § 1(h)(1)(E) sweeps in additional depreciation-attributable gain on real property at 25% federal.

§ 1245 property: full ordinary recapture

Under § 1245(a), gain on the disposition of § 1245 property is ordinary income to the extent of the lesser of (a) recomputed basis minus adjusted basis (the “depreciation amount”), or (b) amount realized minus adjusted basis (total gain). § 1245 property is generally depreciable personal property, plus certain other property described in § 1245(a)(3) (including elevators, escalators, single-purpose ag structures, storage facilities, and the cost-seg-reclassified components of a building).

§ 179 deductions and bonus depreciation under § 168(k) are treated as depreciation for recapture purposes and add to the recapture base. No straight-line carve-out exists for § 1245.

§ 1250 property: actual recapture (rare under MACRS)

Under § 1250(a), gain on real property depreciated using an accelerated method is recharacterized as ordinary income to the extent of “additional depreciation,” meaning depreciation in excess of what straight-line would have allowed. Because MACRS requires straight-line for residential rental and nonresidential real property under § 168(b)(3), there is generally no additional depreciation, and § 1250 recapture is zero.

The exception is pre-1987 ACRS and certain low-income housing depreciated under accelerated methods (Section 168(g) ADS or component depreciation systems where applicable). Not a frequent issue in current files.

Unrecaptured § 1250 gain at 25%

Even when § 1250 recapture itself is zero (the usual MACRS straight-line case), § 1(h)(1)(E) taxes “unrecaptured § 1250 gain” at a maximum 25% federal rate. The unrecaptured amount is the depreciation-attributable portion of the long-term capital gain on § 1250 property, capped at the net § 1231 gain from real property.

This is the rate-arbitrage cost of having depreciated the real property at all: the deductions ran against ordinary income; the corresponding gain at sale runs at 25% rather than 20%. NIIT under § 1411 still applies on top for non-passive-rental investors above the MAGI thresholds.

The cost-seg recapture interaction

A typical cost segregation reclassifies 15–25% of a building’s basis into § 1245 property. On disposition, that portion is subject to full ordinary recapture. The remainder of the building is straight-line § 1250 property with no actual § 1250 recapture but full exposure to the 25% unrecaptured § 1250 rate.

For high-bracket clients, the rate delta between ordinary recapture (up to 37% + 3.8% NIIT) and the 25% unrecaptured § 1250 rate (+3.8% NIIT) is significant. Pair with a planned § 1031 like-kind exchange or hold-to-death plan and the recapture concern recedes; absent that exit, it should be priced into the front-end study decision.

Installment sales

Under § 453(i), depreciation recapture income (§ 1245 and § 1250) is reported in full in the year of sale, regardless of the installment receipts schedule. Only the non-recapture portion of the gain is spread under the gross profit ratio. Practically, this often defeats the cash-flow purpose of installment treatment when the recapture component is the bulk of the gain.

Like-kind exchanges

Under § 1031(a), no gain is recognized on a qualifying like-kind exchange (real property for real property, post-TCJA). Deferred recapture carries over into the basis of the replacement property under § 1245(b)(4) and § 1250(d)(4). Boot received triggers gain to the extent of boot, sourced first against recapture under the recapture-first rules.

The deferred recapture stays with the taxpayer indefinitely under a chain of 1031s, then comes due (or steps up at death) on the final disposition.

Conversion to personal use, gifts, and death

Under T.D. 9132, conversion of MACRS property to personal use is treated as a disposition but does not recognize gain, loss, or recapture; recapture applies on the later personal-use disposition.

A gift is not a recapture event; the recapture potential carries over with the donee’s basis.

Death is the eraser: § 1014 step-up at death eliminates accumulated depreciation recapture entirely, as well as the underlying gain. This is the most efficient recapture mitigation for the long-hold investor.

Passive losses

On a fully taxable disposition of a passive activity, § 469(g)(1)(A) frees suspended passive losses, which then net against the gain (including the recapture portion, treated as gain from the activity). The ordering inside Form 4797 and the relationship to the unrecaptured § 1250 worksheet should be modeled, not estimated.