Recaptured Depreciation: How It’s Calculated and Taxed

Recaptured depreciation is the part of your gain on a sale that the IRS pulls back out of capital-gains treatment because it corresponds to depreciation deductions you already took (or were entitled to take) while you owned the asset. For equipment and other personal property, that portion is taxed as ordinary income at rates up to 37%. For real estate, it’s taxed at a maximum federal rate of 25%. Any gain above your original purchase price is treated separately as long-term capital gain.

How the Calculation Works

Start with your original cost basis: the purchase price plus closing costs, installation, and capital improvements. Subtract all depreciation claimed during ownership. The result is your adjusted basis.1Internal Revenue Service. Topic No. 703, Basis of Assets Sell for more than that adjusted basis and the difference is your realized gain.

That gain splits in two. The first slice equals the depreciation you deducted over the years; this is the recapture. The second slice is anything above your original purchase price, which is capital appreciation and taxed at long-term capital gains rates.

An example. You buy equipment for $50,000 and claim $20,000 of depreciation, leaving an adjusted basis of $30,000. You sell for $60,000. Your total gain is $30,000. Of that, $20,000 is depreciation recapture and $10,000 is capital appreciation.

The Allowed-or-Allowable Rule

The IRS doesn’t care whether you actually claimed depreciation each year. If you were entitled to it, you’re treated as if you took it. Your basis must be reduced by the greater of the depreciation you claimed or the depreciation you should have claimed.2Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis If you never picked a method, the IRS assumes straight-line and reduces basis by that amount.

This trips up owners of rental properties and home offices who skipped the deduction or didn’t know it existed. At sale, recapture is calculated as if every dollar had been claimed. Skipping depreciation doesn’t shield you from recapture; it just means you overpaid income tax along the way for no benefit. The IRS applies the same rule to home office deductions taken under the regular method.3Internal Revenue Service. Depreciation and Recapture

Equipment vs. Real Estate: Why the Asset Type Drives the Rate

Section 1245 Property (Equipment and Personal Property)

Section 1245 covers personal property used in a business or to produce income: machinery, vehicles, office furniture, computers, and certain intangibles like patents. These assets typically depreciate over five to seven years.4Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property

When you sell 1245 property at a gain, the entire recapture amount is taxed as ordinary income at your regular bracket. No reduced rate, no cap. It’s added straight to your income for the year.

Section 1250 Property (Buildings and Structural Components)

Section 1250 covers depreciable real property that isn’t 1245 property: commercial buildings, apartment complexes, rental houses, and structural components like plumbing and HVAC systems permanently attached to a building.5Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty Recovery periods are much longer: 27.5 years for residential rental property and 39 years for commercial buildings.

The gain attributable to depreciation on real estate is called “unrecaptured Section 1250 gain” and is capped at a 25% federal rate instead of your full ordinary rate.6Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed Any gain above the original purchase price is long-term capital gain at 0%, 15%, or 20% depending on income.7Internal Revenue Service. Topic No. 409, Capital Gains and Losses

The Tax Rates in One Place

Higher earners face an additional 3.8% Net Investment Income Tax on capital gains and other investment income once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly. That surtax stacks on top of the rates above, taking unrecaptured Section 1250 gain to an effective 28.8% and long-term capital appreciation to 23.8%.

Section 179 and Bonus Depreciation: Bigger and Sooner

Section 179 lets you deduct the full cost of qualifying equipment in the year of purchase rather than spreading it out. Bonus depreciation works similarly, allowing an immediate write-off of a large percentage of the cost. Both accelerate deductions, which means the potential recapture at sale is larger and arrives sooner.

There’s also a recapture trigger that doesn’t involve a sale. If business use of a Section 179 asset drops to 50% or less before the end of its recovery period, you have to recapture the excess deduction. The amount equals the difference between what you actually deducted and what straight-line depreciation would have given you. That difference is reported as ordinary income in the year business use fell below the threshold.

Installment Sales Don’t Spread the Recapture

Selling on an installment plan normally lets you spread the gain across the years you receive payments. Depreciation recapture doesn’t get that treatment. The full recapture amount is taxable in the year of sale, even if you haven’t received a single dollar yet.9Internal Revenue Service. Publication 537, Installment Sales Only the capital-gain portion beyond the recapture qualifies for installment reporting. Installment sales of depreciated property are reported on Form 6252, which feeds the recapture into Form 4797 while tracking the remaining installment gain separately.

Ways to Defer or Avoid Recapture

Section 1031 Like-Kind Exchanges

Swap one piece of investment or business real estate for another of like kind and you can defer the entire gain, recapture included. No gain or loss is recognized as long as the exchange involves only qualifying real property, and the replacement property inherits the original’s basis, so the deferred recapture travels with you.10Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment

Two constraints matter. Since the 2017 tax reform, Section 1031 applies only to real property, not equipment, vehicles, or other personal property. And you must identify the replacement property within 45 days of transferring the old one and close within 180 days. Miss either window and the full gain becomes taxable.

Stepped-Up Basis at Death

When a property owner dies, heirs generally receive the asset with a basis equal to its fair market value at the date of death.11Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The step-up erases the gap between the depreciated basis and market value, wiping out the recapture that would have been owed if the original owner had sold during life.

The Home-Sale Exclusion Doesn’t Cover This

If you used part of your home as an office or rented a portion, any depreciation claimed on that portion sits outside the Section 121 exclusion. The exclusion of up to $250,000 in gain for single filers ($500,000 for married couples filing jointly) does not apply to gain attributable to depreciation claimed after May 6, 1997. You still owe recapture on that depreciation even when the rest of the profit is fully excluded. Under the allowed-or-allowable rule, this applies whether or not you actually took the deductions.12Internal Revenue Service. Publication 523, Selling Your Home

The Section 1231 Five-Year Lookback

Business property held more than a year is Section 1231 property. A net Section 1231 gain generally qualifies for long-term capital gain treatment. But if you deducted net Section 1231 losses in any of the previous five tax years, your current-year gain is recharacterized as ordinary income to the extent of those prior losses.13Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions

You can’t claim ordinary-rate deductions for losses in prior years and then pay capital-gains rates the moment things turn around. Once those prior losses are fully absorbed, any additional gain returns to capital-gains treatment. The lookback applies before the 1245 and 1250 calculations, so it can quietly enlarge the ordinary-income portion of a sale.

How to Report It

Depreciation recapture is reported on Form 4797, Sales of Business Property.14Internal Revenue Service. Instructions for Form 4797, Sales of Business Property You enter the sale price, original cost basis, and total depreciation claimed; the form separates the ordinary-income portion from any remaining capital gain.

If the gain exceeds the recapture amount, the excess flows to Form 8949 and then to Schedule D of your Form 1040, where all capital gains and losses for the year are netted. For installment sales, Form 6252 tracks payments received across years. Errors in these figures tend to generate IRS notices because the split between ordinary income and capital gains is exactly the kind of mismatch that gets flagged.