What Is Section 1250 Gain and How Is It Taxed?

Section 1250 gain is the portion of your profit from selling depreciable real estate that corresponds to depreciation you claimed (or were entitled to claim) during ownership, and it faces a maximum federal tax rate of 25% rather than the lower long-term capital gains rates that apply to ordinary appreciation.¹ High earners can owe another 3.8% on top. The rule catches many sellers off guard because the IRS reduces your basis by depreciation you were allowed to take even if you never actually took it.

What Property Triggers Section 1250 Gain

The tax code defines Section 1250 property as depreciable real property that isn’t already classified as Section 1245 property.² In practice, that means buildings and their structural components: rental houses, apartment complexes, warehouses, retail buildings, and commercial offices. Roofs, HVAC systems, plumbing, and electrical wiring built into the structure are treated as part of the building.³

Land is never Section 1250 property because it can’t be depreciated. When you sell, you allocate the sale price between land and improvements, and only the building portion is subject to recapture.

Section 1245 property is different, and the difference matters at sale. Machinery, office furniture, vehicles, and similar personal property are Section 1245 assets, and all depreciation on them is recaptured as ordinary income at your full marginal rate, with no cap. Section 1250 property gets more favorable treatment, described below.

How Depreciation Creates the Gain

Every year you own real property used in a business or held for rental income, you deduct part of the building’s cost as depreciation. Residential rental property is depreciated over 27.5 years on a straight-line basis; nonresidential real property uses a 39-year straight-line recovery.⁴ Those deductions reduce your taxable income while you own the property, and they reduce your basis by the same amount.

Say you paid $500,000 for a rental building (excluding land) and claimed $100,000 of depreciation over the years. Your adjusted basis is $400,000. If you sell for $600,000, your total gain is $200,000. The first $100,000 corresponds to depreciation you already deducted, and that’s your Section 1250 gain. The other $100,000 is ordinary capital appreciation and gets the lower long-term capital gains rates.

The Allowed-or-Allowable Trap

Skipping depreciation on your returns doesn’t spare you from recapture. The IRS reduces your basis by the greater of depreciation actually claimed or depreciation you were entitled to claim under the tax code.⁵ Owners who never claimed depreciation because they didn’t want to deal with it lose the annual deduction and still owe the recapture tax at sale. The penalty for inattention runs in both directions.

Two Types of Recapture

The label “Section 1250 gain” covers two different tax treatments, and confusing them produces incorrect returns.

True Section 1250 recapture applies only to depreciation claimed in excess of what straight-line would have allowed. Any excess is taxed at your full ordinary income rate, with no cap. This rarely comes up today because MACRS requires the straight-line method for buildings. It can still appear with older properties depreciated under pre-1987 accelerated methods, or with certain components that used bonus depreciation.²

Unrecaptured Section 1250 gain covers gain attributable to straight-line depreciation and is capped at a 25% federal rate.¹ For nearly every building sold today, this is the category that matters, and it’s what people usually mean when they say “Section 1250 gain.”

How the 25% Rate Actually Works

The 25% figure is a ceiling, not a flat rate. If your ordinary bracket is lower than 25%, you pay your marginal rate instead.⁶ After the Tax Cuts and Jobs Act expires at the end of 2025, the 2026 brackets revert to 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.⁷ A seller in the 15% bracket pays 15% on unrecaptured Section 1250 gain; anyone in the 25% bracket or above pays the full 25%.

Gain beyond the total depreciation you took is taxed at the standard long-term capital gains rates of 0%, 15%, or 20%, depending on income. In the earlier $200,000 example, the first $100,000 hits the recapture rate and the remaining $100,000 hits the capital gains rate.

The 3.8% Net Investment Income Tax

Higher-income sellers owe another layer. The 3.8% net investment income tax applies to gain from property dispositions when your modified adjusted gross income exceeds $200,000 single or $250,000 married filing jointly.⁸ Unrecaptured Section 1250 gain counts. The effective federal ceiling on the recapture portion can therefore reach 28.8%, and the appreciation portion can reach 23.8%. The thresholds are not indexed for inflation.

Section 1231 Netting

Sales of Section 1250 property start as Section 1231 gains. If your total Section 1231 gains for the year exceed your Section 1231 losses, the net gain is treated as long-term capital gain and the recapture portion keeps its 25% rate.⁹ If losses exceed gains, the whole net figure becomes an ordinary loss, which sidesteps the $3,000 annual capital loss cap. Timing multiple property sales across tax years can change the outcome.

Calculating the Gain

Four numbers do the work:

Original purchase price for the building, excluding land.
Capital improvements: new roof, addition, major renovation. These raise your basis.
Total depreciation: what you deducted, or what you were entitled to deduct if that’s larger.⁵
Net sale price: gross sale price minus commissions and closing costs.

Adjusted basis equals purchase price plus improvements minus total depreciation. Total gain equals net sale price minus adjusted basis. Unrecaptured Section 1250 gain is the lesser of total gain or total depreciation. Anything above the depreciation amount is capital appreciation.

A worked example: you buy a commercial building for $800,000 (land excluded), spend $50,000 on improvements, and claim $200,000 in depreciation. Adjusted basis is $650,000. You sell for $950,000 net. Total gain is $300,000. The unrecaptured Section 1250 gain is $200,000, taxed at up to 25%. The remaining $100,000 is taxed at your long-term capital gains rate.

Reporting the Sale

Start with Form 4797 (Sales of Business Property). Part III handles the gain calculation and any Section 1250 recapture computation. Lines 19 through 24 arrive at total gain, and line 26 addresses any depreciation claimed in excess of straight-line.¹⁰

The gain then flows to Schedule D. Inside the Schedule D instructions is the Unrecaptured Section 1250 Gain Worksheet, which separates the depreciation portion from the rest of your capital gains and applies the 25% ceiling.¹¹ Missing this worksheet can cause tax software to apply the wrong rate.

Estimated Tax

A large sale can create an estimated tax obligation. If you expect to owe at least $1,000 after withholding and refundable credits, quarterly estimated payments are generally required.¹² Because sales often close mid-year, you can annualize your income and make a larger payment for the quarter the sale hit, rather than spreading equal payments across the year. The underpayment penalty generally can’t be waived for reasonable cause.¹³

Installment Sales Don’t Spread the Recapture

Selling on an installment basis doesn’t let you spread the recapture tax. All depreciation recapture is recognized in the year of sale, even if you receive no cash that year.¹⁴ Only the gain above the recapture amount can be reported as payments come in. Sellers who don’t plan for this often face a cash-flow shortfall in year one.

Ways to Defer or Eliminate the Gain

The 25% rate isn’t inevitable. Several strategies push it off or wipe it out.

Section 1031 Like-Kind Exchanges

A properly structured like-kind exchange lets you swap one investment or business real property for another without recognizing gain at the time of the exchange.¹⁵ The recapture doesn’t vanish; it transfers to the replacement property along with your carryover basis. Investors chain these exchanges over decades, deferring recapture indefinitely. Since 2018, only real property qualifies. If you receive cash or other non-like-kind property (boot), gain is recognized to the extent of the boot, and depreciation recapture is the first gain recognized.

Stepped-Up Basis at Death

When an owner dies, the heir takes the property with a basis equal to fair market value at the date of death.¹⁶ Accumulated depreciation is effectively erased. A building with a $400,000 adjusted basis worth $900,000 at death becomes $900,000 in the heir’s hands. Sale immediately after produces no gain and no recapture. This is the most powerful way to eliminate Section 1250 gain, and it’s why some investors hold depreciated real estate for life.

Lifetime Gifts

Giving property away during your life doesn’t trigger recapture at the time of the gift.² The recipient inherits your adjusted basis and your depreciation history, so when they sell, they face the recapture you would have owed. A gift shifts the problem; unlike the step-up at death, it doesn’t erase it.

Cost Segregation Increases Recapture

Cost segregation studies reclassify parts of a building from Section 1250 property (27.5 or 39 years) to Section 1245 property (5 or 7 years).¹⁷ Electrical systems serving equipment, decorative finishes, specialized flooring, and some site improvements are common candidates. Shorter recovery periods and eligibility for accelerated depreciation produce bigger deductions early in ownership.

At sale, the trade-off appears. Components reclassified as Section 1245 property face full ordinary income recapture on all depreciation taken, with no 25% cap. $150,000 in accelerated depreciation on reclassified components means $150,000 taxed at your ordinary rate when you sell. Owners who plan to hold long-term, or to roll into a 1031 exchange at sale, get the most from cost segregation; sellers with short horizons may find the recapture eats the early benefit.

1
Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed
2
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
3
Internal Revenue Service. Publication 544, Sales and Other Dispositions of Assets
4
Internal Revenue Service. Publication 527, Residential Rental Property
5
Internal Revenue Service. Depreciation and Recapture
6
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
7
Congress.gov. Expiring Provisions in the Tax Cuts and Jobs Act
8
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
9
Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions
10
Internal Revenue Service. Instructions for Form 4797
11
Internal Revenue Service. Instructions for Schedule D (Form 1040)
12
Internal Revenue Service. Large Gains, Lump Sum Distributions, Etc.
13
Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
14
Internal Revenue Service. Publication 537, Installment Sales
15
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
16
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
17
Internal Revenue Service. Cost Segregation Audit Technique Guide