Depreciation Recapture Under Sections 1245 and 1250

When you sell a business asset you’ve been depreciating, the IRS reclaims part of the tax benefit you got from those deductions through a mechanism called depreciation recapture. Depreciation recapture under Sections 1245 and 1250 of the Internal Revenue Code splits business property into two buckets with very different results: Section 1245 covers equipment, vehicles, and certain intangibles, and it taxes gain tied to prior depreciation at ordinary income rates; Section 1250 covers buildings and other real property, where most sellers face “unrecaptured” gain capped at a 25% rate rather than the top ordinary rate. The rules, rates, and planning options diverge sharply between the two, and a single sale can produce income taxed at two or three different rates on the same return.

How Adjusted Basis Sets Up the Calculation

Every recapture number starts with adjusted basis. You begin with the original cost of the asset, including sales tax, delivery, and installation, and then reduce that figure by the depreciation you claimed (or could have claimed, even if you forgot to take it) each year you owned it.¹ Section 179 expensing and bonus depreciation reduce the basis the same way, often in a single lump in the first year.

Subtract adjusted basis from your sale price and you have your realized gain. Sell below adjusted basis and you have a loss; recapture does not apply. Sell above it and the IRS wants to know how much of that gain traces back to depreciation you already deducted. That figure is the recapture amount.

Section 1245 Property: Equipment, Vehicles, and Intangibles

Section 1245 covers tangible personal property used in a business, including machinery, vehicles, office furniture, computers, and manufacturing equipment. Essentially anything depreciable that is not a building or a structural component of one falls here.² It also reaches certain intangibles. Goodwill, patents, customer lists, and other Section 197 intangibles that you amortize over 15 years are classified as Section 1245 property when sold.³

The recapture rule for Section 1245 property is aggressive. Every dollar of gain attributable to prior depreciation is taxed as ordinary income. The statute recaptures the lesser of your total realized gain or the total depreciation (including Section 179 and bonus depreciation) you claimed over the asset’s life.⁴ Because equipment usually sells for less than its original cost, the entire gain on a Section 1245 asset often ends up taxed at ordinary rates. Only the rare piece of equipment that appreciates above its original purchase price produces any capital gain, and even then only the slice above original cost qualifies.

Fully depreciated assets with a zero basis are not exempt. Sell a piece of equipment you wrote down to nothing, and the entire sale price is recapture income. Business owners who assumed a written-off asset was tax-neutral on paper often learn otherwise at sale.

Section 1250 Property: Buildings and Real Estate

Section 1250 covers depreciable real property, including commercial buildings, warehouses, residential rental structures, and their structural components such as HVAC systems, plumbing, and electrical wiring.⁵ Land itself is never depreciable and never subject to recapture. Only the building and improvements count.

Residential rental property is depreciated straight-line over 27.5 years, and nonresidential property over 39 years.⁶ Because straight-line has been mandatory for real property placed in service after 1986, true Section 1250 ordinary income recapture (which only applies to accelerated depreciation in excess of straight-line) rarely arises for modern buildings. Older properties placed in service before 1987 can still carry that legacy.

What most real estate sellers actually face is a category called unrecaptured Section 1250 gain. This is the portion of gain equal to the straight-line depreciation you claimed during ownership. It is not taxed at your full ordinary rate. Instead, it is capped at 25%, which is better than the top bracket but higher than the standard long-term capital gains rates.⁷ Any gain above your original purchase price is taxed at regular long-term capital gains rates of 0%, 15%, or 20%.

What You Actually Pay: The Rate Stack

A single asset sale can generate income at three different rates:

Section 1245 recapture is taxed at ordinary income rates, which run from 10% to 37% for 2026.
Unrecaptured Section 1250 gain is taxed at a maximum rate of 25%, regardless of your bracket.⁷
Any remaining long-term capital gain (profit above original cost) is taxed at 0%, 15%, or 20%.

Layered on top is the 3.8% Net Investment Income Tax. It applies to individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly).⁸ Net investment income includes gain from property dispositions, so both the capital gain portion and the recapture piece can be caught. A high-income seller of Section 1245 equipment can face a combined rate of 40.8% on the recaptured amount: 37% ordinary plus 3.8% NIIT. Those thresholds are not indexed for inflation, so a large one-time gain from an asset sale increasingly pushes owners over the line.

Working Through the Numbers

The math is methodical. Take sale price, subtract adjusted basis, and that is your total realized gain. Compare that gain to the total depreciation you claimed. Recapture equals whichever number is smaller.

Suppose you bought manufacturing equipment for $100,000 and claimed $100,000 in depreciation over its useful life, leaving an adjusted basis of zero. Sell it for $120,000 and your total gain is $120,000. Only $100,000 represents depreciation you previously deducted, so $100,000 is recaptured as ordinary income and the remaining $20,000 is capital gain.⁴ Sell that same equipment for $80,000 instead, and the entire $80,000 is ordinary income recapture because the gain is smaller than the depreciation claimed. Nothing qualifies for capital gains treatment; recapture eats the whole gain first.

Real estate follows the same logic with the rate distinction built in. Say you bought a commercial building (excluding land) for $500,000 and claimed $200,000 in straight-line depreciation, leaving an adjusted basis of $300,000. You sell for $650,000. Your total gain is $350,000. The first $200,000 is unrecaptured Section 1250 gain taxed at up to 25%. The remaining $150,000, representing true appreciation above your original cost, is long-term capital gain taxed at 0%, 15%, or 20%.

Recapture Can Hit Without a Sale

You do not always need to sell to trigger recapture. If you claimed a Section 179 deduction or bonus depreciation on listed property such as vehicles or computers, and business use drops to 50% or below at any point before the end of the recovery period, you owe recapture on the excess deduction.⁹

The recapture amount is the difference between what you actually deducted and what you would have deducted using straight-line depreciation over the Alternative Depreciation System recovery period. For automobiles, that ADS period is five years. The excess is added back to income in the year business use falls below the threshold.

This trap matters especially in 2026. The One Big Beautiful Bill Act, signed in July 2025, permanently restored 100% bonus depreciation for qualifying property acquired on or after January 20, 2025.¹⁰ Many owners are deducting the full cost of equipment and vehicles in year one. If business use later drops below 50%, the gap between 100% first-year expensing and straight-line is enormous, and so is the recapture bill.

Ways to Defer or Eliminate the Tax

Like-Kind Exchanges Under Section 1031

Swap real property held for business or investment use for other real property of like kind, and Section 1031 lets you defer the entire gain, including depreciation recapture.¹¹ The replacement property takes a reduced basis, carrying the deferred tax forward. Depreciation deductions on the new property are smaller as a result, so the benefit is timing, not permanent savings. If you receive cash or other non-like-kind property (“boot”), gain is recognized up to the value of that boot, with the recapture portion recognized first. Since 2018, Section 1031 applies only to real property. Equipment and vehicles no longer qualify.

Installment Sales

Spreading payments across years lets you spread the capital gain portion under the installment method, but depreciation recapture cannot be deferred this way. The full recapture amount is taxed in the year of sale, regardless of how many payments you actually receive.¹² Sellers who structure installment sales expecting to spread out the tax hit are often surprised when the ordinary income piece hits immediately.

Gifts

Giving away a depreciated asset does not trigger recapture, but it does not erase it either. The recipient inherits your basis (a carryover basis), so the accumulated depreciation and the potential recapture transfer with the asset.¹³ The tax is simply deferred until the new owner sells.

Inherited Property

Death does what no other transaction can: it permanently eliminates depreciation recapture. When an owner dies, heirs receive the asset with a basis stepped up to fair market value at the date of death.¹⁴ All prior depreciation is wiped out. If heirs sell at or near the inherited value, there is little or no gain and no recapture. Holding appreciated, heavily depreciated property until death is one of the most effective tax strategies available.

Reporting on Form 4797

Depreciation recapture is reported on Form 4797, “Sales of Business Property.” Part III handles the actual recapture calculation for both Section 1245 and Section 1250 property.¹⁵ The recapture amount from Part III flows to line 31 and is ultimately reported as ordinary income. Any gain in excess of the recapture amount is reported separately on Form 8949 as a capital gain.

Getting the classification right matters. Mischaracterizing recapture income as capital gain, or leaving it off entirely, can trigger a 20% accuracy-related penalty on the resulting underpayment.¹⁶ The penalty attaches when the underpayment results from negligence or a substantial understatement, meaning an understatement greater than the higher of 10% of the tax owed or $5,000. On a large equipment or real estate sale, the recapture piece alone can easily clear that threshold.

Keep depreciation records throughout ownership, not just at sale. You need the original purchase price, every depreciation deduction claimed (including Section 179 and bonus depreciation), any basis adjustments, and the method used. Reconstructing years of records after the fact is expensive, and the IRS will compute the depreciation you should have taken even if you never claimed it.¹

1
Internal Revenue Service. Publication 551 – Basis of Assets
2
eCFR. 26 CFR 1.1245-3 – Definition of Section 1245 Property
3
eCFR. 26 CFR 1.197-2 – Amortization of Goodwill and Certain Other Intangibles
4
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
5
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
6
Internal Revenue Service. Publication 946 – How To Depreciate Property
7
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
8
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
9
Internal Revenue Service. Instructions for Form 4562
10
Internal Revenue Service. One, Big, Beautiful Bill Provisions
11
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
12
Office of the Law Revision Counsel. 26 USC 453 – Installment Method
13
GovInfo. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
14
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
15
Internal Revenue Service. Instructions for Form 4797
16
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments