Bonus depreciation is subject to recapture. When you sell or otherwise dispose of a business asset on which you claimed bonus depreciation, the IRS taxes your gain as ordinary income up to the total depreciation you previously deducted, not at the lower long-term capital gains rate. Because the current 100% bonus rate often drives an asset’s adjusted basis to zero, the entire sale price can end up as ordinary income.
Why the Deduction Comes Back as Ordinary Income
Bonus depreciation lets you deduct a large percentage of an asset’s cost in the year you place it in service instead of spreading the deduction over its useful life. That upfront deduction reduces your adjusted basis in the asset by the same amount. Take 100% bonus depreciation on a $50,000 machine and your basis drops to zero immediately.
Recapture balances the books when you sell. If the basis is zero and you sell for $30,000, you have $30,000 of gain, and the IRS treats that gain as ordinary income to the extent of the depreciation you previously deducted.1Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property Ordinary rates reach 37% for individual filers, compared to 15% or 20% for most long-term capital gains.2Internal Revenue Service. Federal Income Tax Rates and Brackets Holding period does not save you. Even after ten years of ownership, the depreciation-related portion of the gain still gets ordinary treatment.
The 100% rate matters here because it maximizes recapture exposure. The One, Big, Beautiful Bill Act, signed July 4, 2025, restored 100% bonus depreciation for eligible property acquired after January 19, 2025.3Internal Revenue Service. One, Big, Beautiful Bill Provisions A full first-year deduction means any sale price above zero generates taxable recapture income.
Equipment and Other Section 1245 Property
Section 1245 covers most tangible personal property used in a business: equipment, machinery, furniture, computers, vehicles. On a sale at a gain, the entire gain is taxed as ordinary income up to the total depreciation you claimed, including bonus depreciation. Only gain above that total qualifies for capital gains treatment.4Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property – Section: (a)(1)
Take that $50,000 machine again, basis now zero after 100% bonus depreciation. Sell for $35,000 and the full $35,000 is ordinary income; it sits entirely within the $50,000 of depreciation you claimed. Sell for $60,000 and the first $50,000 is ordinary income (recapturing all the depreciation), with the remaining $10,000 taxed as capital gain because it represents true appreciation above the original cost.
A separate trap applies to listed property such as vehicles and certain electronics. If business use drops to 50% or less during the recovery period, you must include the “excess depreciation” in gross income in that year, calculated as the difference between what you actually deducted and what the straight-line alternative depreciation system would have allowed.5Office of the Law Revision Counsel. 26 USC 280F – Limitation on Depreciation for Luxury Automobiles; Limitation Where Certain Property Used for Personal Purposes – Section: (b)(2) You still own the property, but the tax comes due.
Real Estate and Section 1250 Property
Section 1250 covers depreciable real property: commercial buildings, rental properties, structural components.6Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty – Section: (c) The rules split the gain into layers rather than dumping it all into ordinary income.
Most real property placed in service after 1986 uses straight-line depreciation. Section 1250 recaptures as ordinary income only the depreciation claimed in excess of straight-line, so for typical real estate the ordinary income recapture is often zero. Instead, the depreciation-related gain becomes “unrecaptured Section 1250 gain,” taxed at a maximum rate of 25%.7Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed – Section: (h)(1)(E) Gain above the total depreciation claimed gets the standard 15% or 20% long-term capital gains rate.
Bonus depreciation on real property changes the picture. Qualified improvement property (QIP), which covers interior improvements to nonresidential buildings after the building is placed in service, is eligible for bonus depreciation. Because bonus is an accelerated method, any deduction above what straight-line would have produced counts as “additional depreciation” and can be recaptured as ordinary income under Section 1250. The straight-line portion stays at the 25% rate. Classifying what counts as structural versus interior improvement matters, because it determines which recapture layer applies.
Events That Trigger Recapture Besides a Sale
A sale at a gain is the common case, but several other events produce the same tax obligation.
- Taxable exchanges. Trading an asset in a transaction that does not qualify for nonrecognition treatment triggers recapture just like a sale. Like-kind exchanges under Section 1031 are now limited to real property; equipment, vehicles, and other personal property no longer qualify.8Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
- Involuntary conversions. An insurance payout for destroyed or stolen business property, or a government condemnation award, creates a recapture event. You can defer gain by buying similar replacement property within two years (three for condemned real property), but only gain exceeding the recapture income qualifies for deferral.9Office of the Law Revision Counsel. 26 USC 1033 – Involuntary Conversions
- Foreclosure. Losing business real estate to foreclosure is a disposition that triggers Section 1250 recapture. The holding period for the recapture percentage runs only to the date foreclosure proceedings began, not the date you lost the property.10Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty – Section: (d)(8)
- Business use dropping to 50% or below on listed property, as described above.
- Gifts. A gift generally does not trigger immediate recapture because the recipient takes the donor’s basis, but the recapture potential travels with the asset. When the recipient sells, they face the same calculation.
The Installment Sale Trap
Selling a depreciated business asset on an installment basis, with the buyer paying you over several years, does not spread the recapture tax over those years. All depreciation recapture must be recognized in full in the year of sale, whether or not you received payment that year.11Office of the Law Revision Counsel. 26 USC 453 – Installment Method – Section: (i)
Only the gain exceeding the recapture amount can be reported under the installment method and spread across payment years.12Internal Revenue Service. Publication 537 (2025), Installment Sales The result is a timing mismatch that catches many sellers: a large tax bill in year one while the cash arrives over five or ten. Model this before agreeing to installment terms.
Calculating and Reporting the Recapture
For Section 1245 property, the calculation runs in three steps.
- Find the adjusted basis. Original purchase price minus all depreciation claimed, including bonus. A $50,000 asset with 100% bonus depreciation has a basis of zero.
- Determine the gain. Sale price (or fair market value, if the disposition is not a sale) minus adjusted basis. A $30,000 sale price minus a zero basis is $30,000 of gain.
- Split the gain. Ordinary income up to the lesser of total depreciation claimed or total gain; anything above that is capital gain. In the example, the full $30,000 is ordinary income because it is below the $50,000 of depreciation. At a $60,000 sale price, the first $50,000 is ordinary and the last $10,000 is capital gain.
For Section 1250 real property, insert the middle layer. Depreciation beyond straight-line is ordinary income; the straight-line portion is unrecaptured Section 1250 gain at up to 25%; anything above original cost is a regular capital gain.
You report all of this on Part III of IRS Form 4797, Sales of Business Property. Line 20 captures original cost, Line 21 the sale price, and Line 22 the total depreciation claimed, including bonus depreciation and any special allowance, to determine the ordinary income portion.13Internal Revenue Service. Instructions for Form 4797 (2025) Each asset is calculated separately, even if several are sold in one transaction. Keep records of purchase price, date placed in service, depreciation method, and total deductions claimed for every asset. If you cannot substantiate your depreciation history, the IRS may assume the maximum allowable depreciation was taken and calculate recapture on that higher amount.
Ways to Defer or Reduce the Tax
Recapture is hard to avoid outright, but several moves defer or shrink it.
- Section 1031 exchange, real property only. Swapping one investment or business property for a similar one defers both capital gains and depreciation recapture; the replacement inherits the old property’s basis, so recapture is postponed rather than erased. Equipment and other personal property have not qualified since 2018.8Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
- Step-up in basis at death. Heirs generally receive a basis equal to fair market value on the date of death, which eliminates the built-in depreciation recapture. Some owners chain 1031 exchanges over a lifetime and pass the property to heirs, effectively erasing years of deferred recapture.
- Elect a lower bonus percentage. For the first tax year ending after January 19, 2025, taxpayers may elect 40% bonus depreciation instead of 100%. Taking less upfront cuts recapture exposure if you expect to sell soon.14Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
- Time the sale. Recapture is taxed at your marginal ordinary rate, so selling in a low-income year lowers the bill.
Penalties for Missing the Recapture
Underreporting or omitting depreciation recapture can trigger the IRS accuracy-related penalty of 20% of the underpaid tax. Where the understatement rests on a gross valuation misstatement, such as dramatically overstating an asset’s basis to shrink the recapture, the penalty doubles to 40%.15Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Interest also runs on any underpaid balance, compounding daily from the original due date until paid, at rates the IRS publishes quarterly.16Internal Revenue Service. Quarterly Interest Rates
State Rules May Differ
Federal recapture rules apply uniformly, but many states do not conform to federal bonus depreciation. Some decouple entirely; others cap the percentage they allow. If your state required you to add back some or all of the federal bonus depreciation on your state return, the state recapture on sale will differ too, and you may owe less at the state level because you claimed less depreciation there. Check your state’s conformity rules before projecting the combined tax impact of a sale.