When you sell a fully depreciated business asset, the tax treatment is unforgiving: because years of depreciation deductions have reduced your adjusted basis to zero, the entire sale price (minus selling costs) is a taxable gain, and most or all of it is taxed as ordinary income through depreciation recapture at rates up to 37%.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 The exact split between ordinary income and capital gain depends on what kind of property you sold, whether the sale price exceeded your original cost, and who bought it.
How the Gain Is Calculated
Your adjusted basis starts with what you paid and drops with every depreciation deduction you took.2Internal Revenue Service. Publication 946 (2025), How To Depreciate Property When the asset is fully depreciated, that basis is zero. Anything you receive on the sale, less broker commissions or other selling costs, is your realized gain.
Say you paid $80,000 for equipment, claimed $80,000 in depreciation over the years, and sold it for $25,000. Your gain is the full $25,000. That’s the starting number. How it gets taxed depends on which section of the code the property falls under.
Equipment, Vehicles, and Other Personal Property
Section 1245 covers tangible personal property used in a business: machinery, vehicles, computers, office furniture, and similar assets. When you sell Section 1245 property, gain up to the total depreciation you previously claimed is taxed as ordinary income at your marginal rate.3Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property For a fully depreciated asset, this almost always swallows the entire gain.
Using the $80,000 equipment example: you sold for $25,000, you claimed $80,000 in depreciation, and the recapture cap ($80,000) exceeds your gain ($25,000). The whole $25,000 is ordinary income. No capital gains treatment applies.
If instead you sold the same equipment for $95,000, your gain is $95,000 because basis is zero. The first $80,000 (matching total depreciation) is ordinary income under Section 1245. The remaining $15,000, the amount above your original cost, moves into Section 1231, discussed further down.
The recapture rule doesn’t care which depreciation method you used. Bonus depreciation, MACRS, and Section 179 expensing all count.3Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property If you wrote off $200,000 of equipment under Section 179 in year one and sold it three years later for $50,000, the entire $50,000 is ordinary income. Accelerating the deduction on the front end never reduces recapture on the back end.
Buildings and Other Real Property
Real property (commercial buildings, rental structures) falls under Section 1250, and the treatment is meaningfully better.4Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty Section 1250 only recaptures depreciation as ordinary income to the extent you claimed more than straight-line would have allowed. Virtually all real property placed in service after 1986 must use straight-line, so ordinary-income recapture under Section 1250 is typically zero.
The depreciation still gets taxed, just at a different rate. Gain attributable to straight-line depreciation is classified as “unrecaptured Section 1250 gain” and taxed at a maximum rate of 25%.5Internal Revenue Service. TD 8836 – Unrecaptured Section 1250 Gain
Take a commercial building bought for $500,000, fully depreciated on a straight-line basis over 39 years to zero basis. Sell it for $300,000, and the whole $300,000 gain is unrecaptured Section 1250 gain taxed at the 25% maximum. Sell it for $600,000, and the first $500,000 is at the 25% rate while the remaining $100,000 above original cost is Section 1231 gain.
Allocating Between Land and Building
Land isn’t depreciable, so when you sell improved real property you have to allocate the sale price between the land and the building. Only the building portion produces recapture. The IRS expects the allocation to track fair market value, and shifting an outsized share to land to dodge recapture invites scrutiny. An independent appraisal is the safest support.
Extra Recapture for C Corporations
C corporations face a harsher rule. Under Section 291, a corporation must treat an additional 20% of its total straight-line depreciation as ordinary income on top of whatever Section 1250 would otherwise recapture.6Office of the Law Revision Counsel. 26 USC 291 – Special Rules Relating to Corporate Preference Items For a fully depreciated building, that means 20% of all depreciation claimed becomes ordinary income, and the remaining 80% stays as unrecaptured Section 1250 gain at the 25% rate.
When the Sale Price Exceeds Original Cost
Any gain above your original cost falls under Section 1231, which covers depreciable business property and business real property held more than a year.7Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions Section 1231 gives sellers favorable treatment: net gains for the year qualify for long-term capital gains rates (0%, 15%, or 20%), while net losses are fully deductible against ordinary income.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
This netting only happens after depreciation recapture has been pulled out and taxed as ordinary income. Section 1231 gets what’s left.
The Five-Year Lookback
Congress built in a guardrail. A net Section 1231 gain in the current year is recharacterized as ordinary income to the extent of unrecaptured net Section 1231 losses from the prior five tax years.7Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions If you deducted a $20,000 net Section 1231 loss two years ago and now have a $35,000 net Section 1231 gain, the first $20,000 of that gain flips back to ordinary income. Only the remaining $15,000 gets capital gains rates. Track Section 1231 activity on a rolling five-year window.
The 3.8% Surtax on Investment Income
Higher-income taxpayers may owe an additional 3.8% net investment income tax on gain from selling business property, depending on how actively they were involved in the business. The tax kicks in when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers.8Internal Revenue Service. Net Investment Income Tax Gain from a passive activity is subject to the surtax; gain from a business you actively run is not. Rental property is the common trap, because most landlords are passive unless they qualify as real estate professionals. With the surtax, the effective rate on recaptured depreciation can reach 40.8%, and unrecaptured Section 1250 gain can hit 28.8%.
Installment Sales Won’t Defer the Recapture
Spreading the sale over multiple years through an installment sale does not defer depreciation recapture. The IRS requires you to recognize all recapture income in the year of sale, whether or not you receive any payment that year.9Internal Revenue Service. Publication 537 (2025), Installment Sales Only gain above the recapture amount can be spread over the installment period.
Sell a fully depreciated piece of equipment for $60,000 with payments over three years, and the entire $60,000 of Section 1245 recapture is taxable in year one. You’d report it on Form 4797, Part III, and carry the amount to Form 6252, line 12. If the sale price exceeded original cost, only that excess would qualify for installment treatment. This catches many sellers off guard.
Selling to a Related Party
Selling a depreciable asset to a related party (your own corporation, a family member, a partnership you control) triggers rules that make the tax outcome worse.
Under Section 1239, when you sell to a related person who will use the property as depreciable property, the entire gain is ordinary income, no matter how it would otherwise be classified.10Office of the Law Revision Counsel. 26 U.S. Code 1239 – Gain From Sale of Depreciable Property Between Certain Related Taxpayers Section 1231 capital gains treatment disappears. “Related persons” here includes any entity where you own more than 50% of the stock or partnership interest, plus certain trust arrangements.
Selling at a loss to a related party is worse. Section 267 disallows the loss entirely: you can’t deduct it, and the buyer gets no basis adjustment to compensate.11Office of the Law Revision Counsel. 26 U.S. Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers The relationships that trigger disallowance include family members, entities under common control, and fiduciaries and beneficiaries of trusts.
Ways to Defer or Avoid the Tax
Like-Kind Exchange (Real Property Only)
A Section 1031 like-kind exchange lets you swap one piece of business or investment real property for another without recognizing gain at the time of the exchange. The deferred gain, recapture included, carries over into the replacement property’s basis. Since the Tax Cuts and Jobs Act, 1031 exchanges apply only to real property. Equipment, vehicles, and other personal property no longer qualify. For a fully depreciated building, a 1031 exchange can defer the entire bill until you sell the replacement in a taxable transaction.
Qualified Opportunity Zone Funds
Section 1231 capital gain from the sale can be deferred by investing in a Qualified Opportunity Fund within 180 days. The deferred gain must be recognized by December 31, 2026, or when the QOF investment is sold, whichever comes first.12Internal Revenue Service. Opportunity Zones Frequently Asked Questions With that deadline near, remaining benefit is limited. And only the capital gain portion qualifies; ordinary income from depreciation recapture cannot be deferred through a QOF.
The Step-Up in Basis at Death
If a business owner dies holding a fully depreciated asset, the heir takes a basis equal to the property’s fair market value on the date of death.13Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent All accumulated recapture disappears. An asset with zero basis in the decedent’s hands can have a $200,000 basis in the heir’s hands if that’s fair market value at death. The heir could sell immediately and owe little or no tax.
Charitable Donation (Limited Benefit)
Donating a fully depreciated asset to a qualified charity avoids triggering recapture, but the deduction is capped. When you donate property that would produce ordinary income if sold, your deduction is reduced by that potential ordinary income. For a fully depreciated Section 1245 asset, the deduction is generally limited to adjusted basis, which is zero. Fully depreciated real property can produce a somewhat larger deduction because the unrecaptured Section 1250 gain portion may support it, but the rules are complex.
How to Report the Sale
The sale is reported on Form 4797, Sales of Business Property.14Internal Revenue Service. About Form 4797, Sales of Business Property Part III handles the depreciation recapture calculation, producing an ordinary-income figure that flows to Form 1040. Any remaining gain above original cost moves to Part I, where all Section 1231 transactions for the year are netted and the five-year lookback is applied. Net gain flows to Schedule D as long-term capital gain; net loss flows back to Form 1040 as an ordinary loss.15Internal Revenue Service. Instructions for Form 4797 (2025) Unrecaptured Section 1250 gain is calculated on the Schedule D worksheet at the 25% maximum rate. If the sale is on installment, Form 6252 tracks the payments and coordinates with Form 4797 so recapture is reported in year one.