A Form 4797 example is the fastest way to see what the form actually does: it takes your gain on a business property sale, carves out the portion tied to depreciation you previously deducted, and taxes that piece as ordinary income. Whatever is left gets favorable long-term capital gain treatment. Sell a $25,000-basis machine for $90,000 after claiming $55,000 of depreciation, and the form splits your $65,000 gain into $55,000 of ordinary income and $10,000 of capital gain. The walkthroughs below show how that split runs through Parts I, II, and III for both equipment and a building.
What Belongs on Form 4797
Form 4797 reports sales, exchanges, and involuntary conversions of real or depreciable property used in your trade or business and held more than one year, which the code calls Section 1231 property.1Office of the Law Revision Counsel. 26 U.S. Code 1231 – Property Used in the Trade or Business and Involuntary Conversions Machines, delivery trucks, office furniture, warehouses, rental buildings, and the land under your shop all qualify. The form also captures short-held business property (a year or less) when sold, and involuntary conversions like property destroyed by fire or taken by eminent domain.
Inventory does not go here. Neither do personal capital assets like stocks, bonds, or your home; those belong on Schedule D.2Internal Revenue Service. About Schedule D (Form 1040), Capital Gains and Losses The test is business use: if the asset produced business income or was held for the production of income, it lives on Form 4797.
How the Parts Connect
The form has four parts, and you don’t fill them out in numerical order. That is the single biggest source of confusion.
- Part III comes first for most sales of depreciable business property held longer than a year and sold at a gain. It calculates depreciation recapture.3Internal Revenue Service. Instructions for Form 4797
- Part I nets your Section 1231 gains (the portion left after recapture) against your Section 1231 losses for the year.
- Part II collects everything taxed as ordinary income: property held one year or less, the recapture amount from Part III, and any net Section 1231 loss from Part I.
- Part IV handles Section 179 recapture when business use of an asset falls to 50% or less.
If the property was held more than a year and sold at a gain, start in Part III. Sold at a loss, skip Part III and go straight to Part I. Held one year or less, start in Part II.3Internal Revenue Service. Instructions for Form 4797
Example: Selling Equipment (Section 1245 Property)
Section 1245 covers tangible personal property used in a business: machinery, computers, vehicles, furniture.4Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property The recapture rule is aggressive. You recapture as ordinary income the lesser of the depreciation claimed or the total gain.5Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets Only gain above your original cost survives as Section 1231 gain.
Suppose you bought a CNC machine four years ago for $80,000 and claimed $55,000 of MACRS depreciation. Your adjusted basis is $25,000. You sell it for $90,000.
- Total gain: $90,000 sale price minus $25,000 adjusted basis = $65,000.
- Section 1245 recapture in Part III: the lesser of $55,000 depreciation or $65,000 gain = $55,000 of ordinary income. This flows from Part III, line 31, to Part II, line 13.
- Section 1231 gain to Part I: $65,000 minus $55,000 = $10,000.
With no other Section 1231 transactions and no prior-year lookback losses, that $10,000 becomes long-term capital gain and transfers to Schedule D. The $55,000 recaptured amount is taxed at your ordinary rate. The mechanics are doing exactly what they were designed to do: the depreciation deductions that once offset ordinary income get repaid at ordinary rates before any capital gains treatment kicks in.
Change one number and the picture shifts. Sell the same machine for $70,000 instead of $90,000, and total gain drops to $45,000. Because $45,000 is less than the $55,000 of depreciation you took, the entire gain is recaptured as ordinary income. Nothing survives to reach Part I.
Example: Selling a Commercial Building (Section 1250 Property)
Section 1250 covers depreciable real property: commercial buildings, warehouses, rental housing. The recapture rule is gentler. Only “additional depreciation” beyond what straight-line would have produced is recaptured as ordinary income.6Office of the Law Revision Counsel. 26 U.S. Code 1250 – Gain From Dispositions of Certain Depreciable Realty Because straight-line has been required for nonresidential real property placed in service after 1986, that excess is usually zero on modern buildings.
The straight-line depreciation you claimed is still not tax-free. It becomes “unrecaptured Section 1250 gain,” taxed at a maximum rate of 25% (or your ordinary rate if lower).7Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed Any remaining gain is Section 1231 gain eligible for regular long-term capital gains rates.
Say you bought a commercial building for $390,000 (excluding land). Over 10 years you claimed $100,000 of straight-line depreciation, leaving an adjusted basis of $290,000. You sell the building for $450,000.
- Total gain: $450,000 minus $290,000 = $160,000.
- Section 1250 ordinary recapture in Part III: $0, because you used straight-line and there is no additional depreciation.
- Unrecaptured Section 1250 gain: $100,000, taxed at up to 25%.
- Remaining Section 1231 gain to Part I: $160,000 minus $100,000 = $60,000.
If Part I nets to a gain overall, the $60,000 flows to Schedule D as long-term capital gain. The $100,000 unrecaptured portion also reaches Schedule D but runs through the tax worksheet that applies the 25% cap.
One trap: the land under the building is not depreciable and has no recapture. Allocate your sale price between building and land by fair market value, report the building in Part III, and report the land separately in Part I as its own Section 1231 transaction.
A note on entity type. If a C corporation sells Section 1250 property, an additional slice equal to 20% of what full Section 1245 recapture would have produced is treated as ordinary income under Section 291, even when regular Section 1250 recapture is zero.8Office of the Law Revision Counsel. 26 U.S. Code 291 – Special Rules Relating to Corporate Preference Items Individuals and passthrough owners are not subject to this add-on.
Netting in Part I and the Five-Year Lookback
Part I nets all your Section 1231 gains against all your Section 1231 losses for the year. A net gain is treated as long-term capital gain. A net loss is treated as an ordinary loss, fully deductible against wages and business income with no $3,000 cap. That asymmetry is one of the most valuable features of Section 1231.
The catch is the lookback. Under Section 1231(c), if you deducted net Section 1231 losses as ordinary in any of the five preceding tax years, this year’s net Section 1231 gain must be recharacterized as ordinary income up to the amount of those unrecaptured prior losses.1Office of the Law Revision Counsel. 26 U.S. Code 1231 – Property Used in the Trade or Business and Involuntary Conversions
Worked out: you had net Section 1231 losses of $4,000 in 2021 and $6,000 in 2022, both deducted against ordinary income. In 2025 you had a $3,000 net Section 1231 gain, which recaptured $3,000 of those prior losses. Going into 2026, $7,000 of unrecaptured loss remains. In 2026, you produce a net Section 1231 gain of $8,000. The first $7,000 is taxed as ordinary income; only $1,000 qualifies as long-term capital gain. Once the prior losses are fully recaptured, they do not come back.
If you have had Section 1231 losses in the last five years, run the lookback before assuming your equipment or building sale will be taxed at capital gains rates.
Installment Sales: Recapture Comes Due Up Front
When you sell business property and take payments over several years, Section 453’s installment method lets you spread the gain over the payment years using Form 6252. Depreciation recapture is the exception. All ordinary income from Section 1245 or Section 1250 recapture is taxable in the year of sale, whether or not you have received the cash yet.9Internal Revenue Service. Form 6252 – Installment Sale Income
You still complete Part III to compute the recapture, and that number flows to Part II as year-one ordinary income. Only the Section 1231 portion above recapture can be deferred through Form 6252. On a heavily depreciated asset, the front-loaded tax on recapture can dwarf the first year’s payments, so run those numbers before you agree to the terms.
Where the Numbers End Up
Form 4797 is a feeder form. The pieces have to arrive at the right lines on your main return.
- Ordinary gain or loss from Part II, line 18: individuals send this to Schedule 1 (Form 1040), Part I, line 4. Partnerships report it on Form 1065, Schedule K, line 10. S corporations use Form 1120-S, Schedule K, line 9.10Internal Revenue Service. Form 4797 – Sales of Business Property
- Net Section 1231 gain from Part I, after any lookback recharacterization, transfers to Schedule D as long-term capital gain.11Internal Revenue Service. Instructions for Schedule D (Form 1040)
- Unrecaptured Section 1250 gain flows through the Schedule D tax worksheet, where the 25% maximum rate is applied separately from your other long-term gains.
Before filing, trace each number off Form 4797 to its destination. Ordinary income belongs on Schedule 1, capital gains on Schedule D, and passthrough amounts on the correct Schedule K line. A number that leaves Form 4797 without landing anywhere is one of the more common reasons a return gets kicked back.