Depreciation Recapture — How the IRS Claws Back §§ 1245 and 1250 Deductions

When you sell business or investment property, any gain attributable to depreciation deductions you took in prior years gets "recaptured" — taxed at ordinary income rates rather than the preferential long-term capital gains rate. This is depreciation recapture, governed primarily by 26 U.S.C. §§ 1245 and 1250. The policy logic is straightforward: if depreciation deductions reduced your income tax at ordinary rates (up to 37%), it would be unfair to then tax the resulting gain at the lower capital gains rate (0%, 15%, or 20%). Recapture is one of the most common and often overlooked tax surprises for business owners and real estate investors — property that looks like a simple capital gain may actually carry a significant ordinary income component.

Current Law (2026)

Parameter	Value
§ 1245 recapture	All depreciation claimed on personal property (equipment, vehicles, most intangibles) recaptured at ordinary income rates (up to 37%)
§ 1250 recapture	Only "additional depreciation" (accelerated over straight-line) on real property recaptured at ordinary rates; most real property held post-1987 has zero § 1250 recapture
Unrecaptured § 1250 gain	Straight-line depreciation on real property: taxed at maximum 25% rate (not ordinary rates)
§ 1231 gain	Gain above all recapture amounts; qualifies for long-term capital gains rates if § 1231 "hotchpot" net is positive
Bonus depreciation interaction	§ 179 expensing and bonus depreciation are treated as § 1245 property recapture when sold
Like-kind exchange	§ 1031 exchange defers recapture as well as underlying gain; recapture carries over into replacement property
Depreciation subject to recapture	All "allowed or allowable" depreciation — includes depreciation you should have taken but didn't
Maximum ordinary rate	37% for individuals; 21% for C-corporations
Unrecaptured § 1250 max rate	25% for individuals (does not apply to C-corps, which pay flat 21%)

Legal Authority

26 U.S.C. § 1245 — Gain from dispositions of certain depreciable property: captures all depreciation (including § 179 expensing and bonus depreciation) taken on personal property; treats as ordinary income the lesser of the recomputed basis minus adjusted basis, or the amount realized over adjusted basis
26 U.S.C. § 1250 — Gain from dispositions of certain depreciable realty: applicable percentage of "additional depreciation" (accelerated over straight-line) on real property recaptured as ordinary income; since ACRS and MACRS use straight-line for residential and non-residential real property, § 1250 ordinary recapture is rare for property placed in service after 1987
26 U.S.C. § 1231 — Property used in trade or business: net § 1231 gains (after recapture is carved out) taxed as long-term capital gains if the annual hotchpot is net positive; § 1231 losses treated as ordinary losses (fully deductible)
26 U.S.C. § 168 — Modified Accelerated Cost Recovery System (MACRS): the depreciation system that generates the amounts subject to recapture; defines property class lives (5-year, 7-year, 27.5-year for residential rental, 39-year for non-residential real property)
26 U.S.C. § 179 — Immediate expensing election: § 179 deductions on personal property are treated as depreciation for § 1245 recapture purposes
26 U.S.C. § 168(k) — Bonus depreciation: immediate expensing of eligible property (100% through 2022; phasing down through 2026) also subject to § 1245 recapture on disposition

The Three-Layer Gain Analysis

When you sell business or investment property, the gain must be analyzed in layers — each layer has different tax treatment:

Layer 1 — Ordinary income (§ 1245 or § 1250 recapture): The gain attributable to prior depreciation, treated as ordinary income. For personal property (equipment, vehicles), this is all prior depreciation. For real property, this is only accelerated depreciation (rarely applicable after 1987).

Layer 2 — "Unrecaptured § 1250 gain": For real property, the straight-line depreciation that was taken is not ordinary income under § 1250, but it's not eligible for the 0%/15%/20% long-term capital gains rates either. Instead, it's taxed at a maximum rate of 25%. This is the "unrecaptured Section 1250 gain" that appears on Schedule D.

Layer 3 — § 1231 gain (or loss): Gain above the recapture amounts gets § 1231 treatment. If the overall § 1231 hotchpot for the year is net positive (more gains than losses from all business/investment property sales), this gain is taxed as long-term capital gain at the 0%, 15%, or 20% rate. If net negative, the entire amount is an ordinary loss — which is actually more favorable than capital loss treatment.

Section 1245 Recapture — Personal Property

Section 1245 is aggressive: it recaptures all depreciation claimed, not just accelerated depreciation. The recaptured amount is the lesser of:

The gain realized (amount realized minus adjusted basis), or
All depreciation/amortization previously allowed or allowable (the "recomputed basis" minus the adjusted basis)

Example: You bought business equipment for $50,000, took $40,000 in depreciation (adjusted basis now $10,000), and sold it for $35,000. Your gain is $25,000 ($35,000 minus $10,000). All $25,000 is ordinary income under § 1245 because the gain ($25,000) is less than total depreciation taken ($40,000).

Example 2: Same equipment, sold for $55,000. Gain is $45,000. Section 1245 recapture is $40,000 (all prior depreciation). The remaining $5,000 is § 1231 gain eligible for capital gains rates.

Allowed or allowable: Recapture applies to depreciation that was "allowed or allowable" — meaning even if you forgot to take depreciation you were entitled to, the IRS treats you as having taken it anyway. If you should have claimed $10,000 in depreciation over three years but only claimed $5,000, your recapture calculation still uses $10,000.

Property subject to § 1245:

Tangible personal property (equipment, machinery, computers, vehicles)
Intangible property amortized under § 197 (goodwill, patents, customer lists — if used in a business)
Single-purpose agricultural/horticultural structures
Storage facilities (other than buildings)
Property expensed under § 179 (treated as depreciation for recapture purposes)
Property subject to bonus depreciation

Section 1250 Recapture — Real Property

Section 1250 applies to "real property" — buildings and structural components. For real property placed in service after 1986, the MACRS depreciation system uses straight-line depreciation (27.5 years for residential rental property; 39 years for non-residential commercial property). Because MACRS is already straight-line, there is no "additional depreciation" (no excess over straight-line), and § 1250 ordinary income recapture is generally zero for modern real estate.

Section 1250 would create ordinary income only if:

The property was placed in service before 1987 under ACRS, which allowed accelerated methods
The taxpayer used the accelerated rehabilitation investment credit under the old § 167(k)
Special circumstances created additional depreciation over straight-line

For practical purposes, most investors selling post-1987 real estate will encounter zero § 1250 ordinary income recapture — but they will still face the "unrecaptured § 1250 gain" tax at 25%.

The 25% Rate on Unrecaptured § 1250 Gain

Even though § 1250 doesn't create ordinary income for modern real estate, Congress still wanted to tax straight-line depreciation at a rate above the long-term capital gains rate. The result is the "unrecaptured § 1250 gain" rule in § 1(h) — a 25% maximum rate (not 0%/15%/20%) on the portion of real estate gain attributable to prior straight-line depreciation.

Example: You purchased a rental house in 2015 for $300,000, claimed $54,545 in straight-line depreciation (27.5 year life × $300,000 / 1 = ~$10,909/year × 5 years ≈ $54,545), bringing your adjusted basis to $245,455. You sell for $400,000.

Total gain: $154,545
Unrecaptured § 1250 gain: $54,545 (all prior depreciation) — taxed at maximum 25%
§ 1231 gain: $100,000 — eligible for 0%/15%/20% long-term capital gains rates

If you're in the 15% capital gains bracket, this is particularly stinging — the depreciation piece costs you 25% instead of 15%.

Bonus Depreciation and § 179 — Accelerated Recapture Risk

The Tax Cuts and Jobs Act of 2017 expanded 100% bonus depreciation for eligible property placed in service through 2022, phasing down to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. Section 179 expensing (up to $1.22 million in 2026) continues with full expensing.

While these provisions reduce taxes in the year property is placed in service, they create maximum recapture exposure when property is sold. A business that expensed $500,000 of equipment under § 179 has adjusted basis of $0 — any sale proceeds create immediate ordinary income up to $500,000. Business owners who used aggressive § 179 or bonus expensing must track potential recapture carefully when planning equipment sales or business sales.

Effect on Like-Kind Exchanges

A § 1031 like-kind exchange defers not just the underlying gain but also the recapture. The "excess depreciation" carries over into the replacement property — when you eventually sell the replacement property without another exchange, the deferred recapture hits.

However, § 1031 can be combined with installment sale reporting for the boot (cash or non-like-kind property received), creating complex interactions. The recapture on boot received is recognized in the year of the exchange, even if the overall gain would otherwise be deferred.

Installment Sales and Recapture

Under § 453, recapture income (§ 1245 and § 1250 ordinary income) is always recognized in the year of sale — it cannot be spread over the installment period. Only the § 1231 gain component can be spread over installments. This is a critical planning point: a seller who takes back a large note may still owe significant tax in year one on the recapture component.

How It Affects You

If you're selling business equipment or vehicles: Pull your Form 4562 depreciation schedule (or your tax software's asset register) before finalizing a selling price. The recapture calculation: gain recognized up to total prior depreciation is ordinary income at rates up to 37%. Equipment bought for $50,000 with $40,000 in depreciation (adjusted basis $10,000) sold for $35,000 generates $25,000 gain — all ordinary income because the gain ($25,000) is less than the depreciation taken ($40,000). If sold for $55,000: $45,000 gain, of which $40,000 is ordinary recapture and $5,000 is § 1231 gain at LTCG rates. If you took § 179 expensing or 100% bonus depreciation, your basis may be zero — meaning a larger fraction of sale proceeds are ordinary income. Since TCJA 2017 limited § 1031 exchanges to real property (personal property no longer qualifies), there's no deferral vehicle for equipment recapture; the only planning lever is timing the sale to a lower-income year where the ordinary recapture hits a lower marginal bracket.

If you're selling rental real estate: Before closing, have your CPA model all three gain layers. For post-1987 property using MACRS straight-line, ordinary § 1250 recapture is typically zero — but the unrecaptured § 1250 gain (all prior straight-line depreciation) is taxed at a maximum 25% rate rather than the 0%/15%/20% LTCG rates. In the example from this page: a $300,000 rental house with $54,545 in accumulated depreciation sold for $400,000 generates $54,545 at 25% (unrecaptured § 1250) and $100,000 at LTCG rates. The 25% rate is fixed — even taxpayers normally in the 15% LTCG bracket pay 25% on this layer. Installment sale reporting can spread the § 1231 gain layer over multiple years, but recapture (ordinary income layer) is always recognized in the year of sale regardless of payment timing. To defer all three layers, use a § 1031 exchange — the carryover basis means the recapture defers into the replacement property rather than disappearing.

If you're selling a business with assets (asset sale vs. stock sale): In an asset sale, § 1245 recapture applies separately to each depreciable asset at the time of closing. A seller who expensed $500,000 in equipment under § 179 has a zero basis in those assets — meaning $500,000 in ordinary income from those assets alone, on top of any gain from goodwill, real estate, or other assets. This is the core of the asset-vs.-stock-sale negotiation: sellers nearly always prefer stock sales (where the corporation's inside basis in assets isn't triggered and the gain is capital gain at the shareholder level), while buyers prefer asset sales (to get a fresh, stepped-up depreciable basis for post-closing depreciation). The tax cost of recapture is a real deal cost — buyers often offer a lower price for a stock deal or demand an asset deal at a premium. Work with an M&A tax advisor to model both structures and quantify the allocation before entering purchase price negotiations.

If you're a real estate investor who used cost segregation: Cost segregation reclassifies portions of building costs from 27.5-year or 39-year real property into 5-year, 7-year, and 15-year personal property, generating accelerated depreciation deductions in early years. The recapture trade-off: when you sell, the reclassified personal property components are subject to § 1245 recapture at ordinary income rates (up to 37%) rather than the more favorable 25% maximum rate for § 1250 unrecaptured gain. On $200,000 of reclassified property fully depreciated, the difference can be $24,000+ in additional tax (37% ordinary vs. 25% recapture rate) at a top-bracket rate. The net present value of the timing benefit (large deductions in early years at 37%) versus the higher recapture rate on sale requires explicit analysis — it almost always comes out positive when the holding period is long enough, but the analysis depends on your current bracket, projected sale timeline, and whether you'll execute a § 1031 exchange at disposition.

State Variations

Most states conform to federal depreciation and recapture rules, but California and several other states decoupled from federal bonus depreciation — they do not allow 100% immediate expensing and require you to depreciate assets over their normal MACRS lives. This creates different recapture amounts for state vs. federal purposes in those states. Track California and any other non-conforming state separately.

Implementing Regulations

26 CFR 1.1245-1 — General rule for treatment of gain from dispositions of certain depreciable property (§ 1245 ordinary income recapture for personal property; recapture amount limited to gain or depreciation taken)
26 CFR 1.1245-2 — Definition of recomputed basis (computation of recapture amount: depreciation/amortization deductions allowed or allowable)
26 CFR 1.1245-3 — Definition of section 1245 property (which property is subject to recapture: tangible personal property, certain real property used as integral part of manufacturing, etc.)

Pending Legislation

The Tax Cuts and Jobs Act of 2025 provisions being debated in Congress would potentially extend or make permanent 100% bonus depreciation. If extended, this would perpetuate the recapture risk described above — maximum-rate recapture when expensed assets are later sold. Some proposals would also expand § 1031 to include personal property (TCJA 2017 limited § 1031 to real property), which if enacted would reduce recapture exposure on equipment by allowing deferral through like-kind exchanges.

Recent Developments

OBBBA restoring 100% bonus depreciation — recapture timing reset: The One Big Beautiful Budget Act (2025) restored and made permanent 100% bonus depreciation for qualified property (reversing the scheduled phase-down to 60% for 2024, 40% for 2025, 20% for 2026). The restoration means taxpayers who purchased assets in 2024 and 2025 at reduced bonus rates now face a planning question: whether to file amended returns for elective adoption of the restored rates or accept the phased rates. Critically, the accelerated depreciation from 100% bonus increases the § 1245 recapture exposure on eventual sale — a $1M piece of equipment fully expensed creates $1M of ordinary income recapture rather than the capital gain rate that would apply to gain above original cost. The OBBBA restoration makes recapture management (holding periods, like-kind exchange strategies) more important than it was during the phase-down years.
Cost segregation IRS audit activity intensifying: The IRS announced in 2023-2024 that cost segregation studies — which accelerate depreciation by reclassifying building components from 39-year (nonresidential real property) to 5, 7, or 15-year property — are a high-priority examination area. Aggressive cost segregation studies that reclassify structural components (HVAC, plumbing, elevators) as personal property have been challenged; the IRS's Coordinated Issue Paper on cost segregation establishes examination standards. When these reclassifications are reversed on audit, § 1245 recapture is reassessed and accuracy-related penalties may apply. Taxpayers with large real estate cost segregation studies should expect IRS scrutiny at examination.
§ 1250 unrecaptured gain — 25% rate on prior straight-line depreciation in real estate sales: When real estate held for more than a year is sold, § 1250 unrecaptured gain (the depreciation taken on real property) is taxed at a maximum 25% rate — above the standard 20% long-term capital gain rate. For investors who have held real estate for decades and taken significant straight-line depreciation, the § 1250 unrecaptured gain component can be substantial. Tax planning for high-depreciation real estate typically focuses on § 1031 like-kind exchanges to defer recapture, installment sale structures to spread recapture recognition, or charitable remainder trust strategies to avoid immediate recapture.
Section 179 expensing interaction with recapture on early disposition: Property expensed under § 179 (immediate deduction rather than depreciation) is subject to § 1245 recapture if disposed of before the end of its depreciable life. For businesses that expense equipment and then sell it within a few years — particularly in mergers, acquisitions, or rapid technology upgrade cycles — the § 179 recapture creates ordinary income at disposition. Buyers in asset acquisitions typically don't inherit the seller's § 179 recapture risk, but recapture analysis is a standard part of asset purchase due diligence for buyers seeking to confirm the seller's tax basis claims and the character of anticipated gain in the sale.