Unrecaptured Section 1250 Gain

Unrecaptured Section 1250 Gain — Overview and Practical Guide

An unrecaptured Section 1250 gain arises when depreciable real property (for example, rental or commercial buildings) is sold for more than its adjusted basis and some of that gain is attributable to previously claimed depreciation. The portion attributable to depreciation is “recaptured” and taxed at a special rate: up to 25% for the depreciation-related portion, with any remaining gain taxed at the applicable long-term capital gains rate.

Key points

• Applies only to depreciable real property (Section 1250). Personal property (machinery, equipment) is handled under Section 1245.
• The depreciation-related portion of the gain is taxed at a maximum 25%.
• Unrecaptured Section 1250 gains are realized only when there is a net Section 1231 gain (i.e., after offsetting Section 1231 losses).
• Capital losses can offset these gains, but short-term and long-term classifications must match when offsetting.

How it works

1. Depreciation reduces your tax basis in a property. When you sell, the adjusted basis = original cost − accumulated depreciation.
2. Gain on sale = sale price − adjusted basis.
3. The portion of gain equal to prior depreciation (or the allowable recapture amount) is treated under Section 1250 and taxed up to 25%.
4. Any gain beyond the recaptured depreciation is treated as a regular long-term capital gain (if the asset was held long-term).

Section 1250 recapture is determined within the broader Section 1231 framework, which combines gains and losses on depreciable business property held more than one year. Net Section 1231 losses are treated as ordinary losses; net gains get capital gain treatment but with special recapture rules for depreciation.

Example

• Purchase price: $150,000
• Accumulated depreciation: $30,000
• Adjusted basis: $120,000 (150,000 − 30,000)
• Sale price: $185,000
• Total gain: $65,000 (185,000 − 120,000)

Depreciation-related portion = original purchase price − adjusted basis = $30,000.
Tax treatment:
* $30,000 is subject to unrecaptured Section 1250 tax (up to 25%).
* Remaining $35,000 (65,000 − 30,000) is taxed at the long-term capital gains rate.

How to calculate Section 1250 recapture

Section 1250 recapture is the lesser of:
1. The excess of accelerated depreciation claimed on the real property over the depreciation that would have been allowable using straight-line depreciation, or
2. The gain realized on disposition.

In practice, IRS worksheets and instructions guide the computation; the recapture amount is then reported on Form 8949 and Schedule D and carried to Form 1040.

What triggers depreciation recapture?

Recapture is triggered when the sale price exceeds the property’s adjusted tax basis — the difference attributable to prior depreciation is subject to recapture rules. Recapture can also be affected by how depreciation was claimed (accelerated vs straight-line).

Typical Section 1250 property

• Commercial buildings (depreciated under MACRS over a 39-year recovery period)
• Residential rental property (depreciated over 27.5 years)
  These are examples of real property subject to Section 1250 rules.

Special considerations and strategies

• Offsetting gains: Capital losses can offset unrecaptured Section 1250 gains, but short-term losses cannot offset long-term gains and vice versa without matching classifications.
• 1031 like-kind exchanges: A properly executed Section 1031 exchange can defer recognition of gain, including recapture, by exchanging property for like-kind property. This defers, but does not permanently eliminate, tax.
• Converting to a primary residence: Changing use of a property may affect taxation and exclusion eligibility but does not automatically eliminate prior depreciation recapture.
• Inheritance (stepped-up basis): Heirs generally receive a stepped-up basis to fair market value at death, which can reduce or eliminate recapture for the heir if they sell the property thereafter.

Reporting

Recapture amounts and related gains/losses are typically reported on Form 8949 and Schedule D, then flowed through to Form 1040. Follow IRS instructions and worksheets to ensure correct classification and computation.

Bottom line

Unrecaptured Section 1250 gain represents the portion of a real-property gain attributable to prior depreciation. That portion is taxed at a maximum 25%, while the remainder of any long-term gain is taxed at standard long-term capital gains rates. Careful basis tracking, correct depreciation methods, and awareness of offsetting losses and deferral strategies (like 1031 exchanges) can materially affect tax liability at sale.