Section 1245 vs 1250 Property: Recapture, Exchanges, and Reporting

Section 1245 property is depreciable personal property used in a business (equipment, vehicles, machinery, and certain specialized structures), while Section 1250 property is depreciable real property (buildings and their structural components). The difference matters most at sale: Section 1245 converts all prior depreciation into ordinary income taxed at rates up to 37%, while Section 1250 typically caps the depreciation-related gain at 25%.¹ On the same dollar of recaptured depreciation, that rate gap can swing tens of thousands of dollars.

What Falls on Each Side

Section 1245 covers tangible personal property you depreciate for business use: machinery, office furniture, computers, delivery trucks, and manufacturing equipment. It also reaches some less obvious categories. Single-purpose agricultural and horticultural structures, petroleum storage facilities, and railroad grading or tunnel bores all fall under Section 1245.¹ Tangible real property that serves a manufacturing, production, or extraction function (as opposed to a general-purpose building) can qualify too.

Amortizable intangibles belong here as well. Goodwill, patents, customer lists, and other Section 197 intangibles are treated as Section 1245 property when you dispose of more than one in the same transaction or a series of related transactions.² Section 179 expensing follows the same logic: any amount you expensed under Section 179 is treated as depreciation for recapture purposes.³

Section 1250 is the catch-all for depreciable real property that isn’t Section 1245. In practice that means buildings and structural components: commercial offices, retail spaces, warehouses, apartment buildings, and residential rentals.¹ Land is never Section 1250 property because land isn’t depreciable. Qualified improvement property, which covers interior improvements to nonresidential buildings such as new flooring, interior walls, and lighting systems, is also Section 1250 property. That classification carries a consequence worth watching, because QIP now qualifies for bonus depreciation.

How Section 1245 Recapture Works

Section 1245 recapture is blunt. When you sell at a gain, all depreciation you previously claimed is reclassified as ordinary income. The recapture amount equals the lesser of your total gain or the total depreciation you took on the asset, including any bonus depreciation or Section 179 expense.² That ordinary income lands at your marginal tax rate, which can reach 37% in 2026.⁴

A worked example: you buy a machine for $50,000, claim $40,000 of depreciation over several years, and sell for $55,000. Your adjusted basis is $10,000, giving a total gain of $45,000. Under Section 1245, $40,000 of that gain (the full depreciation amount) is ordinary income. Only the remaining $5,000, representing the sale price above your original cost, qualifies as Section 1231 gain eligible for long-term capital gains treatment.

One trap: the IRS doesn’t care whether you actually claimed the depreciation. The rule reaches depreciation “allowed or allowable.” If you could have depreciated an asset but didn’t, you still owe recapture on the depreciation you should have taken.⁵

How Section 1250 Recapture Works

Section 1250 recapture was originally built to claw back only the portion of depreciation that exceeded what straight-line would have produced.⁶ Because the Tax Reform Act of 1986 forced most real property onto the straight-line method, buildings placed in service after 1986 generally produce no excess depreciation to recapture as ordinary income.¹

Instead, the depreciation you took on real property typically falls into a category called unrecaptured Section 1250 gain. This equals the cumulative straight-line depreciation claimed (up to the total gain on the sale), and it’s taxed at a maximum rate of 25%.⁷ The 25% figure is a ceiling, not a floor; if your ordinary rate is lower, you pay the lower rate. Any gain beyond the depreciation amount and above your original cost is taxed at the standard long-term capital gains rates of 0%, 15%, or 20%.

Compare the same numbers under 1250 treatment. You buy a rental property (excluding land) for $300,000, claim $80,000 in straight-line depreciation, and sell for $350,000. Adjusted basis is $220,000, so gain is $130,000. The first $80,000 is unrecaptured Section 1250 gain taxed at up to 25%. The remaining $50,000 is standard long-term capital gain. Under Section 1245, that same $80,000 would be ordinary income at rates up to 37%. That is the rate gap in a single transaction.

The Bonus Depreciation Trap on Real Property

The return of 100% bonus depreciation in 2026 complicates the clean split above.⁸ For Section 1245 property, bonus depreciation changes nothing at sale, since the recapture was already going to ordinary income. For Section 1250 property such as qualified improvement property, the arithmetic shifts.

Section 1250 ordinary income recapture targets depreciation in excess of straight-line. Regular straight-line produces no excess, so there’s nothing to recapture at ordinary rates, only the 25% unrecaptured gain. Bonus depreciation, by definition, exceeds straight-line. If you took 100% bonus depreciation on QIP in year one, the difference between what you claimed and what straight-line would have produced is additional depreciation under Section 1250, and that portion is recaptured as ordinary income when you sell.⁹

Say you spend $200,000 on interior improvements and claim 100% bonus depreciation. Straight-line over 15 years would have given you about $13,333 in year one. The remaining $186,667 is additional depreciation. Sell the building two years later at a gain, and that $186,667 is recaptured at ordinary rates, not the 25% rate many owners expect on real property.

Hybrid Sales and Cost Segregation

Most commercial building sales involve both sections at once. A single transaction bundles Section 1250 property (the shell and structural components), Section 1245 property (specialized equipment, certain electrical and plumbing systems, removable fixtures), and non-depreciable land. Sales proceeds get allocated across those components, and each follows its own recapture rules.

A cost segregation study is the engineering and tax analysis that performs the allocation. It reclassifies components eligible for shorter depreciation periods, often 5 or 7 years instead of the 27.5-year residential or 39-year nonresidential recovery period for the building itself.¹ Dedicated electrical wiring for manufacturing equipment, process piping, and specialized HVAC installed for production are common reclassifications.

The upfront benefit is faster deductions. The sale-side cost is that every dollar reclassified as Section 1245 property faces full ordinary income recapture instead of the 25% unrecaptured Section 1250 rate. Over a long hold, the time value of earlier deductions generally outweighs the eventual recapture. Over a short hold, the trade-off is less obvious and deserves careful analysis before the study is ordered.

Transactions That Defer or Erase Recapture

Not every disposition triggers recapture. A few paths change the picture entirely.

Gifts

Gifting Section 1245 or 1250 property doesn’t trigger recapture for the donor. The recipient takes the donor’s basis and depreciation history, and the latent recapture travels with the property. When the recipient sells, they owe what the donor would have owed.

Transfers at Death

Death erases recapture. The property’s basis is stepped up to its fair market value on the date of death, which wipes out accumulated depreciation.¹⁰ Heirs receive a clean basis with no embedded recapture.

Like-Kind Exchanges

A Section 1031 like-kind exchange defers both gain and recapture, which carry over to the replacement property. If you receive cash or other non-like-kind property as boot, gain is recognized up to the boot amount, and recapture applies to that recognized gain first.¹¹ Section 1031 is now limited to real property, so this path doesn’t rescue Section 1245 personal property.

Installment Sales

Installment sales offer no help on recapture. Even if you spread the purchase price over years, all depreciation recapture under both Section 1245 and Section 1250 must be recognized in the year of sale, regardless of how much cash you’ve actually received.¹² Only gain above the recapture amount can be spread over the installment period.

Extra Layers Worth Knowing

C-Corporation Add-On Under Section 291

C-corporations face an extra layer on Section 1250 sales. Under Section 291, a C-corporation treats 20% of the difference between full Section 1245 recapture (what the ordinary income would be if the property were equipment) and actual Section 1250 recapture as additional ordinary income.¹³ It doesn’t apply to S-corporations, partnerships, or individuals.

The 3.8% Net Investment Income Tax

Higher-income taxpayers may owe the 3.8% Net Investment Income Tax on gains from selling investment or rental property. It applies when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), thresholds that don’t adjust for inflation.¹⁴ For rental property and passive investments, both Section 1245 recapture income and unrecaptured Section 1250 gain can be caught. The effective maximum on unrecaptured Section 1250 gain can reach 28.8%, and Section 1245 recapture can reach 40.8% for taxpayers above the thresholds. Gains from property used in an active trade or business where you materially participate are generally outside the NIIT.

Section 1231 and the Five-Year Lookback

After 1245 and 1250 recapture take their share, any remaining gain on the sale of a business asset is typically Section 1231 gain. When your Section 1231 gains for the year exceed your Section 1231 losses, the net is treated as long-term capital gain. The five-year lookback rule, though, recharacterizes current Section 1231 gains as ordinary income to the extent of unrecaptured net Section 1231 losses in the prior five tax years.¹⁵ You can’t deduct losses at ordinary rates and then flip to capital rates when the market turns.

Where This Gets Reported

Both Section 1245 and Section 1250 recapture calculations run through IRS Form 4797, Sales of Business Property. Part III handles the recapture math: Section 1245 property on Line 25, Section 1250 property on Line 26, where you compute any additional depreciation (excess over straight-line) that’s recaptured as ordinary income.⁹ For Section 1250 property depreciated purely on a straight-line basis with no bonus depreciation, Line 26 typically produces zero. The unrecaptured Section 1250 gain taxed at the 25% maximum is calculated separately on the Schedule D worksheet. When you sell hybrid property, Part III needs separate entries for each component; the form doesn’t combine them for you.

1
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
2
Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property
3
Internal Revenue Service. Instructions for Form 4562 (2025)
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Internal Revenue Service. Depreciation and Recapture
6
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
7
Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed
8
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
9
Internal Revenue Service. Instructions for Form 4797 (2025)
10
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
11
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
12
Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets
13
Office of the Law Revision Counsel. 26 U.S. Code 291 – Special Rules Relating to Corporate Preference Items
14
Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax
15
Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions