What Is Section 1250 Property and How Is It Taxed?

Section 1250 property is depreciable real estate — buildings, rental houses, apartment complexes, warehouses, retail storefronts, and the structural components inside them. Land is never included because land cannot be depreciated.¹ When you sell at a profit, the portion of your gain that matches the depreciation you claimed over the years is taxed at a federal rate of up to 25%, higher than the long-term capital gains rates most sellers expect.² The rest of the gain is taxed at ordinary long-term capital gains rates. Planning for both layers is what separates a clean sale from a surprise tax bill.

What Qualifies as Section 1250 Property

Any real property that is or has been eligible for depreciation falls under Section 1250. That includes commercial office buildings, apartment complexes, warehouses, retail storefronts, single-family rentals, and structural components like roofing, plumbing, electrical systems, and walls. Depreciable land improvements such as parking lots, sidewalks, and landscaping are often included too, though some can shift into Section 1245 depending on the depreciation method elected.

Land itself is excluded. If you buy a rental for $400,000 and allocate $100,000 to land and $300,000 to the building, only the $300,000 building piece is Section 1250 property. That split matters at sale because only the building’s depreciation creates recapture exposure.

One carve-out worth knowing: if you took a Section 179 deduction on qualifying real property improvements like a new roof, HVAC, fire alarm, or security system in a nonresidential building, the IRS reclassifies the deducted amount as Section 1245 property for recapture. The reclassified portion is taxed as ordinary income rather than at the 25% rate.

How the Tax Works When You Sell

Modern real estate placed in service after 1986 must use straight-line depreciation under MACRS. Residential rentals depreciate over 27.5 years and nonresidential property over 39 years.³ Because straight-line is mandatory, the original Section 1250 recapture-as-ordinary-income rule almost never bites. What applies instead is “unrecaptured Section 1250 gain”: the straight-line depreciation you claimed, taxed at a maximum federal rate of 25% when you sell.²

At the sale, the IRS splits your gain into layers. The unrecaptured Section 1250 layer equals the lesser of your total gain or the total depreciation claimed. Anything above that layer is taxed at the standard long-term capital gains rates of 0%, 15%, or 20%.

Here is how the math plays out on a straightforward sale:

Purchase price: $500,000
Depreciation claimed over the holding period: $100,000
Adjusted basis at sale: $400,000
Sale price: $650,000
Total gain: $250,000

The unrecaptured Section 1250 gain is the lesser of $250,000 or $100,000, so $100,000 is taxed at up to 25%. The remaining $150,000 is taxed at your long-term capital gains rate. At the full 25%, the recapture piece alone costs $25,000.

The 25% figure is a ceiling, not a flat rate. If your marginal ordinary income rate is lower than 25%, the unrecaptured gain is taxed at that lower rate instead. You report the sale on IRS Form 4797, which separates ordinary income recapture, 25% rate gain, and residual capital gain.⁴ The unrecaptured amount then flows to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

One timing trap: if you sell within a year of acquiring the property, all depreciation adjustments count as “additional depreciation” and the gain tied to them is taxed as ordinary income.¹ The rest of the profit also loses long-term capital gains treatment. The difference between an 11-month and a 13-month holding period can be dramatic.

The “Allowed or Allowable” Trap

Some owners think they can dodge recapture by skipping depreciation deductions. They can’t. Your basis must be reduced by depreciation “allowed or allowable, whichever is greater.”⁵ “Allowed” is what you actually deducted. “Allowable” is what you were entitled to deduct, whether you claimed it or not.

Own a rental for ten years and never take depreciation? The IRS still reduces your basis by every dollar you could have deducted, and you owe recapture tax at sale on deductions you never used. Claim the depreciation each year you’re entitled to it. The alternative is paying tax on a benefit you threw away.

What Pushes Your Actual Bill Higher

The 25% headline rate is only part of the real cost. Several surcharges and parallel rules stack on top.

The 3.8% Net Investment Income Tax

High earners pay an additional 3.8% surtax on net investment income, including gain from selling Section 1250 property. It kicks in when modified adjusted gross income exceeds $250,000 for joint filers, $200,000 for single filers, or $125,000 for married filing separately.⁶ These thresholds aren’t indexed for inflation.

Both the unrecaptured Section 1250 gain and the residual long-term capital gain count toward net investment income.⁷ Effective federal rates can reach 28.8% on the recapture portion (25% plus 3.8%) and 23.8% on the remaining capital gain (20% plus 3.8%).

State Income Tax

The 25% cap and the NIIT are federal only. Most states tax capital gains as ordinary income and don’t honor the federal distinction between unrecaptured Section 1250 gain and other capital gains. State rates on this gain run from zero in no-income-tax states to over 13% in the highest-tax states. On a large property, ignoring state tax can leave a five-figure gap between projected and actual net proceeds.

Extra Recapture for C Corporations

C corporations face an additional layer under Section 291. When a corporation sells Section 1250 property, 20% of the difference between what Section 1245 would have recaptured and what Section 1250 actually recaptured is treated as ordinary income.⁸ Because straight-line depreciation produces zero regular Section 1250 recapture, the practical effect is that 20% of the total depreciation becomes ordinary income. On $200,000 of depreciation, that’s $40,000 taxed at ordinary corporate rates. Holding real estate inside a C corporation is less tax-efficient at sale than holding it individually or through a pass-through.

Ways to Defer or Erase the Recapture

Section 1031 Like-Kind Exchange

A 1031 exchange lets you swap one investment property for another of equal or greater value without recognizing gain at the time of the exchange. The unrecaptured Section 1250 gain isn’t erased; it rolls into the replacement property by reducing its depreciable basis. When you eventually sell in a taxable transaction, the deferred recapture comes due along with any new depreciation claimed on the replacement.

The deferral can repeat indefinitely across successive exchanges. The trade-off is that each replacement starts with a lower depreciable basis, producing smaller annual deductions than buying fresh at full market value would. If you receive cash or other non-like-kind property (boot), gain is recognized up to the boot amount and characterized under the recapture rules as if you had sold outright.

Installment Sales Don’t Spread the Recapture

Selling on installments usually spreads gain recognition across the years payments arrive. Not for Section 1250 recapture. The full recapture amount must be recognized in the year of sale, regardless of when the buyer actually pays.⁹ The remaining gain still qualifies for installment treatment, with unrecaptured Section 1250 gain taken into account before adjusted net capital gain, so earlier payments carry a higher tax rate.¹⁰ Budget for the recapture tax in year one, even if the first payment barely covers it.

Gift Versus Inheritance

Transferring the property during your lifetime passes your basis and your entire depreciation history to the recipient.¹¹ When they sell, they face the same unrecaptured Section 1250 gain you would have owed. The gift itself triggers no income tax, but the recapture liability travels with the property.

Inheritance works very differently. Property acquired from a decedent receives a basis equal to fair market value at the date of death.¹² That step-up wipes out accumulated depreciation, so the heir faces zero unrecaptured Section 1250 gain on a later sale (unless they claim new depreciation after inheriting). On heavily depreciated property, the savings can be large enough that holding until death becomes a deliberate estate strategy.

Reporting Through a Partnership or S Corporation

If you hold Section 1250 property through a partnership or an LLC taxed as a partnership, your share of the unrecaptured gain appears on Schedule K-1 (Form 1065) in Box 9c when the partnership sells the property.¹³ If you sell your partnership interest rather than the partnership selling the asset, your share of gain attributable to the partnership’s Section 1250 assets is reported under Box 20, Code AD. The partnership itself owes no tax; each partner reports the allocation on the Unrecaptured Section 1250 Gain Worksheet in their Schedule D instructions.

S corporation shareholders receive the equivalent information on K-1 (Form 1120-S). The line differs, but the result is identical: the character of the gain passes through to the individual return. A pass-through structure doesn’t let you escape the 25% rate.

Watch for these K-1 allocations, because they feed directly into your Schedule D and determine how much of your sale proceeds you actually keep.

1
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
2
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
3
Office of the Law Revision Counsel. 26 US Code 168 – Accelerated Cost Recovery System
4
Internal Revenue Service. Instructions for Form 4797 (2025)
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
6
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
7
eCFR. 26 CFR 1.1411-4 – Net Investment Income
8
Office of the Law Revision Counsel. 26 US Code 291 – Special Rules Relating to Corporate Preference Items
9
Office of the Law Revision Counsel. 26 US Code 453 – Installment Method
10
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain Reported on the Installment Method
11
Office of the Law Revision Counsel. 26 US Code 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
12
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
13
Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065)