Section 1250: Taxation of Depreciated Real Property

What is Section 1250?

Section 1250 of the Internal Revenue Code addresses how gains from the sale of depreciable real property are taxed when depreciation taken on the property exceeds what would have been allowed under the straight-line method. When accelerated depreciation methods have produced larger earlier deductions, the portion of gain attributable to that excess depreciation can be recaptured and taxed as ordinary income rather than as capital gain.

This rule applies to depreciable real property (for example, commercial buildings, rental homes, barns) — not to land or to most personal property or intangible assets.

Key points

• Section 1250 can reclassify part of a sale gain as ordinary income if accelerated depreciation exceeded straight-line depreciation.
• The ordinary income recapture is limited to the actual gain realized on the sale.
• If the depreciation taken was equal to (or only equal to) straight-line depreciation, Section 1250 ordinary-income recapture generally does not apply.
• Certain transfers — gifts, transfers at death, and qualifying like-kind exchanges — typically avoid Section 1250 recapture on the transfer itself.
• Since 1987 the IRS generally requires straight-line depreciation for most real estate, so Section 1250 recapture is less common for post-1986 property.

How it works

1. Determine total gain on sale: sale price minus adjusted basis (original cost less all accumulated depreciation).
2. Calculate how much accumulated depreciation exceeds what straight-line depreciation would have been over the same period.
3. The lesser of (a) that excess depreciation and (b) the realized gain is taxed as ordinary income under Section 1250.
4. Any remaining gain (to the extent it exceeds recaptured ordinary income) is taxed at capital gains rates.

Example

An investor buys a rental building for $800,000 with a 40-year recovery period.

• After 5 years, accelerated depreciation claimed = $120,000 (adjusted basis = $680,000).
• Straight-line depreciation over 5 years = ($800,000 / 40) × 5 = $100,000.
• Excess depreciation = $120,000 − $100,000 = $20,000.

If the building sells for $750,000:
* Total realized gain = $750,000 − $680,000 = $70,000.
* Up to $20,000 (the excess depreciation) may be recaptured and taxed as ordinary income.
* The remaining $50,000 of gain is taxed as capital gain.

If the building instead sells for $690,000:
* Total realized gain = $10,000.
* Section 1250 ordinary-income recapture cannot exceed the realized gain, so only $10,000 is taxed as ordinary income (not the full $20,000 excess depreciation).

Practical considerations

• Because straight-line depreciation has been required for most real property placed in service after 1986, many modern real estate dispositions do not result in Section 1250 ordinary-income recapture — but older holdings or special depreciation allowances can still produce recapture exposure.
• Tax outcomes vary by taxpayer type and transaction; state tax rules may differ.
• Always review depreciation history and consult a tax advisor before selling depreciable real estate to understand potential recapture and planning options.

Source: IRS Publication 544.