How to Fill Out Form 4797: Gains, Losses, and Recapture

To fill out Form 4797, sort every business-property disposition into one of the form’s four parts based on how long you held the asset and whether you claimed depreciation, calculate any depreciation recapture as ordinary income first, then let whatever gain remains flow through as a Section 1231 capital gain. Getting the sort right is what determines your tax rate on each dollar. Getting it wrong can trigger a 20 percent accuracy-related penalty on top of the tax.¹

The current form and instructions are available as fillable PDFs on the IRS site.² One boundary before you start: if the only thing you sold was inventory to customers in the ordinary course of business, Form 4797 is not the right form. Inventory belongs on Schedule C or your entity’s equivalent income schedule.³

Records You Need Before You Open the Form

Pull these together for every asset you sold, exchanged, or lost during the year:

The acquisition date. This decides whether the asset is “held more than one year” or “one year or less,” and that single fact routes the gain into a different part of the form and a different tax rate.
The date of sale, exchange, condemnation, or other disposition.
The gross sales price, before subtracting broker commissions, legal fees, or other selling costs.
The original cost or other basis, including purchase price, closing costs, and the value of improvements you made over the years.
A depreciation or amortization schedule showing every year’s deduction since you placed the asset in service.

The depreciation schedule is the record that catches people out. The tax code treats you as though you claimed the depreciation that was “allowed or allowable,” meaning the amount you could have deducted whether or not you actually took it. Skipping depreciation in earlier years does not reduce your recapture at sale. If your records are thin, reconstruct the schedule before you start on the form. Leaving the depreciation fields blank does not make the recapture go away; it just guarantees a wrong answer.

Which Part Does Your Sale Belong In

The four parts of Form 4797 are not alternatives you pick between. A single asset often touches two of them. The sorting rules:

Held more than one year, sold at a gain, with depreciation claimed: start in Part III to calculate recapture, then the remainder flows to Part I.
Held more than one year, sold at a loss, or held more than one year with no depreciation: Part I only.
Held one year or less, or a non-capital asset regardless of holding period: Part II.
Section 179 asset whose business use dropped to 50 percent or less: Part IV, regardless of whether you sold anything.

Held for exactly one year counts as “one year or less” and goes in Part II. The line is strict, and misplacing an asset shifts the entire gain into the wrong tax category.

Part I: Section 1231 Property Held More Than One Year

Part I is where gains and losses on long-held business property get their favorable treatment. Section 1231 assets include real estate used in a trade or business, depreciable equipment, timber, and certain livestock.² A net gain here is taxed at long-term capital gain rates. A net loss is treated as ordinary and offsets any type of income without the $3,000 annual cap that applies to capital losses.

For each asset, enter the description, acquisition date, sale date, gross sales price, depreciation allowed or allowable, cost basis, and the resulting gain or loss. Installment payments from a prior-year sale come in from Form 6252 onto line 4. Recognized gains or losses from like-kind exchanges reported on Form 8824 go on line 5.³

All Part I transactions net together on line 7. Before that number reaches Schedule D, though, line 8 asks a question that trips up many filers.

The Five-Year Look-Back Rule

If you claimed net Section 1231 losses in any of the five preceding tax years, your current-year net Section 1231 gain is reclassified as ordinary income up to the total of those unrecaptured prior losses.⁴ Only the remaining gain gets long-term capital gain treatment.

If you deducted $7,000 of Section 1231 losses across the past five years and none has been recaptured yet, the first $7,000 of this year’s gain is ordinary income. Anything above that is capital gain.⁵ With no prior losses, line 8 is zero and the net gain flows through untouched.

Part II: Ordinary Gains and Losses

Part II handles assets held one year or less, and non-capital assets regardless of holding period.² Everything reported here is taxed as ordinary income or produces an ordinary loss. Enter the same fields as Part I: description, dates, gross sales price, depreciation, adjusted basis, and gain or loss. Individuals reporting losses on qualifying Section 1244 small-business stock also use Part II, which converts what would otherwise be a capital loss into an ordinary loss.³

Part III: Depreciation Recapture

Part III is where the IRS claws back the benefit of the depreciation you deducted while you owned the property. If you reduced taxable income with depreciation and then sold at a gain, a portion of that gain is taxed at ordinary rates rather than the lower capital gain rate. Only assets sold at a gain and held longer than one year go through Part III. Sold at a loss, skip it.

Section 1245 Property

Section 1245 covers tangible personal property (machinery, vehicles, furniture, computers) and amortizable intangibles like goodwill, customer lists, and other Section 197 intangibles. On a sale at a gain, the entire gain is ordinary income up to the total depreciation or amortization you claimed.⁶ Only gain above total depreciation gets Section 1231 treatment.

Worked example. You bought equipment for $50,000, claimed $30,000 of depreciation, and sold it for $60,000. Adjusted basis is $20,000, so total gain is $40,000. The first $30,000 is ordinary income (matching the depreciation). The remaining $10,000 moves to Part I as Section 1231 gain.

Section 1250 Property

Section 1250 applies to depreciable real property, mostly commercial buildings and rental structures. For real property placed in service after 1986 and depreciated using the straight-line method, Section 1250 itself generally does not produce additional ordinary-income recapture. But a separate layer called “unrecaptured Section 1250 gain” taxes the depreciation-related portion of your gain at a maximum rate of 25 percent rather than the 15 or 20 percent capital gain rate.⁷

Many sellers of commercial buildings assume the entire gain will be taxed at 15 or 20 percent and are surprised by the 25 percent slice. You calculate the amount in Part III and then report it on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

If you used an accelerated depreciation method on an older building, the excess depreciation over the straight-line amount is recaptured as ordinary income under Section 1250, and the straight-line portion is taxed at the 25 percent rate.

Goodwill and Other Section 197 Intangibles

When you sell a business, part of the price is often allocated to goodwill, customer lists, or other intangibles amortized over 15 years. These are treated as Section 1245 property for recapture.⁸ Gain is ordinary income up to the amortization you claimed; anything above that moves to Part I. Report them in Part III the same way you would machinery.

Part IV: Section 179 Recapture

Part IV applies in a narrow but expensive situation. You claimed a Section 179 expense deduction for an asset, and its business use later dropped to 50 percent or less.² You owe back the difference between the Section 179 deduction you took and the regular depreciation you would have been allowed without it, reported as ordinary income in the year business use dropped.

No sale is required. Converting a truck from 100 percent business use to 40 percent personal use is enough to trigger it. Part IV walks through the math.

Sales That Require Another Form First

Several dispositions run through a separate form before their numbers land on Form 4797.

Installment Sales

If you’ll receive payments across more than one tax year, report the sale on Form 6252, then bring the gain onto Form 4797 line 4 (long-term Section 1231 property) or line 15 (ordinary-income amounts).³ Depreciation recapture is not eligible for installment treatment. The full recapture is taxed in the year of sale even if the cash hasn’t come in yet.⁹

Like-Kind Exchanges

Exchanges of business real estate under Section 1031 go on Form 8824 first. Any gain or loss recognized because you received cash or other non-like-kind property in the deal flows to Form 4797, line 5 or line 16.³ The deferred portion does not appear on Form 4797 until you eventually dispose of the replacement property in a taxable transaction.

Casualty and Theft Losses

Business property that was destroyed, damaged, or stolen goes on Form 4684 first. If the property was held more than one year and involves potential depreciation recapture, complete Form 4797 Part III for the recapture rather than handling it entirely on Form 4684.¹⁰ Insurance proceeds that exceed your adjusted basis in destroyed business property produce Section 1231 gains that flow through Part I.

Sales to Related Parties

Sell business property at a loss to a related party and the loss is disallowed entirely. Related parties include family members, a corporation you own more than 50 percent of, trusts where you are the grantor or beneficiary, and several other relationships in the code.¹¹ The rule applies even at genuine fair market value. Still report the transaction, but the loss produces no tax benefit. The buyer can use your disallowed loss to reduce their gain if they later resell to an unrelated party.

Where the Numbers Land on Your Return

After all four parts are done, the totals scatter:

Net Section 1231 gain from Part I flows to Schedule D and is taxed at long-term capital gain rates, after the look-back rule has done its work.²
Net Section 1231 loss from Part I goes to Form 1040 as an ordinary loss, fully deductible against other income.
Ordinary gains and losses from Part II go to the income lines of Form 1040.
Depreciation recapture from Part III: the ordinary-income piece goes to Form 1040; the unrecaptured Section 1250 piece follows the Schedule D worksheet at the 25 percent maximum rate.
Section 179 recapture from Part IV adds to ordinary income on Form 1040.

When a single asset produces both Part III recapture and Part I gain, the form handles the split automatically. Recapture stays in Part III as ordinary income; only the amount above total depreciation moves to Part I.

The 3.8 Percent Surtax the Form Doesn’t Mention

Gains reported on Form 4797 can trigger the net investment income tax, an extra 3.8 percent surtax that catches many business owners off guard. It applies to individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly).¹² Those thresholds are not indexed for inflation.

The tax is 3.8 percent of the lesser of your net investment income or the amount by which your modified AGI exceeds the threshold. Net investment income includes gains from disposing of property not held in certain active trades or businesses.¹² Sell a rental building at a $300,000 gain with income well above the threshold and expect roughly $11,400 in additional tax on top of income tax and capital gains tax. Report it on Form 8960, not Form 4797, but the Form 4797 gain is what triggers it.

Records to Keep After You File

The IRS generally has three years from the filing date to assess additional tax. If you omit more than 25 percent of your gross income, that window extends to six years.¹³ An overstated cost basis counts as an omission of gross income under this rule, and a single business-asset sale can easily be big enough to push a mistake past the 25 percent threshold.

Keep purchase agreements, closing statements, depreciation schedules, and a copy of the completed Form 4797 for at least six years. The three-year minimum is the floor, and the cost of storing records is trivial compared to the cost of not being able to prove your basis in an audit.

1
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
2
Internal Revenue Service. About Form 4797, Sales of Business Property
3
Internal Revenue Service. Instructions for Form 4797
4
Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions
5
IRS.gov. 2025 Instructions for Form 4797 Sales of Business Property
6
Office of the Law Revision Counsel. 26 USC 1245 – Gain from Dispositions of Certain Depreciable Property
7
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
8
Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets
9
IRS.gov. Form 6252 – Installment Sale Income
10
RegInfo.gov. Instructions for Form 4684
11
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest with Respect to Transactions Between Related Taxpayers
12
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
13
Office of the Law Revision Counsel. 26 USC 6501 – Limitations on Assessment and Collection