Sell a piece of business equipment or a rental building for more than its depreciated book value, and the IRS wants a share of every dollar of depreciation you deducted along the way — often at a rate well above the capital gains rate you were expecting. This is depreciation recapture, and which flavor applies — §1245 or §1250 — determines whether that share is taxed at your full ordinary rate or capped at 25%.
The distinction is entirely about asset type. §1245 covers personal property — machinery, vehicles, equipment, furniture, computers. §1250 covers real property — buildings and their structural components. Mix the two up and you can overstate a tax bill by tens of thousands of dollars, or underpay and trigger an IRS notice years later. Run your own numbers with the Depreciation Recapture Calculator.
Why Recapture Exists
Depreciation is a deduction against ordinary income while you own the asset — it lowers your taxable income year after year at your marginal rate, which for many owners is 22%–37%. If the asset is later sold for more than its depreciated basis, the IRS treats some or all of that gain as “recapturing” the tax benefit you already banked, rather than letting it slip into the lower-taxed long-term capital gains bucket. Depreciation recapture is not a penalty — it is the flip side of the deduction: the government gets back, at ordinary-income rates (or a capped rate for real estate), what it let you deduct at ordinary-income rates.
§1245 vs §1250 at a Glance
| §1245 (Personal Property) | §1250 (Real Property) | |
|---|---|---|
| Covers | Equipment, machinery, vehicles, furniture, computers, some land improvements | Buildings, structural components of real estate |
| Recapture treatment | ALL depreciation recaptured as ordinary income | Depreciation-attributable gain is “unrecaptured §1250 gain,” capped at a 25% maximum federal rate |
| Rate ceiling | None — taxed at your full marginal rate, up to 37% | 25% max, or your ordinary marginal rate if lower |
| Gain above recapture | Treated as §1231 gain, taxed at LTCG 0/15/20% rates | Treated as ordinary appreciation, taxed at LTCG 0/15/20% rates |
| NIIT | 3.8% applies to the investment-income portion if over MAGI threshold | Same |
| Reported on | Form 4797, Part III | Form 4797, Part III + Schedule D Unrecaptured §1250 Gain Worksheet |
§1245 — Personal Property / Equipment
Under IRC §1245, when you sell depreciable personal property used in a trade or business, every dollar of gain up to the total depreciation you claimed is recaptured as ordinary income — no cap, no discount. If your equipment sale gain exceeds the depreciation taken, that excess is §1231 gain and gets the more favorable long-term capital gains treatment (0/15/20%).
This is the harsher of the two regimes because there is no rate ceiling: a filer in the 35% or 37% bracket pays that full rate on the recaptured portion. Section 1245 property includes:
- Machinery and equipment used in a business
- Vehicles, computers, office furniture
- Certain land improvements (fences, paved parking) and single-purpose agricultural structures
- Amortizable intangibles claimed under accelerated methods in some cases
§1250 — Real Property
Under IRC §1250, the recapture rules are gentler in two ways. First, the technical §1250 rule only recaptures depreciation taken in excess of straight-line — and since the Tax Reform Act of 1986 required real property to be depreciated using straight-line MACRS, there is usually no actual excess-depreciation recapture for buildings placed in service after 1986.
But that doesn’t mean the depreciation escapes tax at a discount. A separate rule under IRC §1(h) creates the “unrecaptured §1250 gain” category: the portion of your long-term capital gain equal to the straight-line depreciation you claimed is carved out and taxed at a maximum federal rate of 25% (or your ordinary marginal rate, if that happens to be lower) — instead of being folded into the standard 0/15/20% LTCG brackets. It remains a capital-gains-regime item (reported via the Schedule D worksheet), but it is priced well above the 15%/20% most real estate gain enjoys.
Any remaining gain — the appreciation above what you depreciated — is taxed at the ordinary 0/15/20% LTCG rates.
How Basis, Depreciation, and Sale Price Interact
The mechanics are the same for both regimes; only the recapture rate differs.
Adjusted basis = Original cost + Capital improvements − Depreciation taken
Amount realized = Sale price − Selling costs
Total gain = Amount realized − Adjusted basis
Depreciation recapture = min(Depreciation taken, Total gain)
Remaining gain = Total gain − Depreciation recaptureTwo clamps matter:
- Recapture never exceeds the gain itself. If you sell at a loss, or for less than your adjusted basis, there is no recapture even if you claimed substantial depreciation.
- Recapture never exceeds the depreciation actually taken. You can’t recapture more than the deduction you claimed.
The recapture stacks first, on top of your other taxable income, through the ordinary bracket table (capped at 25% for §1250, uncapped for §1245). The remaining gain then stacks above the recapture through the long-term capital gains bracket table.
Worked Example A — §1245 Equipment Sale
A single filer’s business bought manufacturing equipment for $150,000 and fully depreciated it ($150,000 of accumulated depreciation) before selling it in 2026 for $180,000, with $5,000 of selling costs. The owner’s other 2026 taxable income is $150,000.
| Item | Amount |
|---|---|
| Original cost | $150,000 |
| Depreciation taken | $150,000 |
| Adjusted basis | $0 |
| Sale price | $180,000 |
| Selling costs | $5,000 |
| Amount realized | $175,000 |
| Total gain | $175,000 |
- Depreciation recapture = min($150,000, $175,000) = $150,000, taxed as ordinary income (§1245, no cap)
- Remaining gain = $175,000 − $150,000 = $25,000, taxed as §1231 gain at LTCG rates
Stacking the $150,000 recapture on top of $150,000 of other 2026 taxable income runs through the single-filer ordinary brackets (10%–37%) from $150,000 to $300,000, landing in the 24%, 32%, and 35% bands — $45,171.25 of recapture tax, an average rate of about 30.1% on the recaptured dollars. The remaining $25,000 lands in the 15% LTCG bracket: $3,750. Net investment income tax adds $4,750 (3.8% of $125,000 of MAGI over the $200,000 single threshold). Total federal tax on the sale: $53,671.25.
Because §1245 has no rate ceiling, this owner’s recapture is taxed noticeably above the 25% cap that would apply if this had instead been a §1250 real property sale.
Worked Example B — §1250 Rental Building Sale
A single filer bought a rental property for $300,000, added $20,000 of capital improvements, and claimed $80,000 of straight-line depreciation before selling in 2026 for $500,000, with $20,000 of selling costs. Other 2026 taxable income is $150,000.
| Item | Amount |
|---|---|
| Original cost | $300,000 |
| Improvements | $20,000 |
| Depreciation taken | $80,000 |
| Adjusted basis | $240,000 |
| Sale price | $500,000 |
| Selling costs | $20,000 |
| Amount realized | $480,000 |
| Total gain | $240,000 |
- Depreciation recapture (unrecaptured §1250 gain) = min($80,000, $240,000) = $80,000
- Remaining gain (appreciation) = $240,000 − $80,000 = $160,000
Stacking the $80,000 of unrecaptured §1250 gain on top of $150,000 of other taxable income runs from $150,000 to $230,000. The first $51,775 falls in the 24% ordinary bracket (below the 25% cap, so it applies uncapped at 24%); the remaining $28,225 would otherwise fall in the 32% bracket, but the 25% ceiling caps it down. Recapture tax: $19,482.25 — an effective rate of about 24.4%, versus the roughly 27% it would have been at this owner’s marginal rate with no cap.
The remaining $160,000 of appreciation stacks above that, landing entirely in the 15% LTCG bracket: $24,000. NIIT adds $7,220 (3.8% of $190,000 of MAGI over the $200,000 single threshold). Total federal tax on the sale: $50,702.25 — net proceeds after tax of $429,297.75.
Compare the two examples: both filers realized similar-sized gains, but the §1245 seller paid recapture at roughly 30% while the §1250 seller was capped at 25% on the equivalent slice — the structural advantage of owning depreciated real estate over depreciated equipment.
NIIT Stacks on Top of Both Regimes
The 3.8% Net Investment Income Tax applies to the lesser of (a) net investment income for the year or (b) the amount your MAGI exceeds the filing-status threshold ($200,000 single/head of household, $250,000 married filing jointly/qualifying surviving spouse, $125,000 married filing separately). For a rental or investment-property sale, both the recapture and the remaining gain count as net investment income — NIIT does not distinguish between §1245, §1250, or plain LTCG. High-income sellers should budget for it as a near-certain add-on, not an edge case.
§1031 Exchanges Defer Recapture — They Don’t Eliminate It
A like-kind exchange under IRC §1031 defers gain recognition, including depreciation recapture, by rolling your basis into the replacement property instead of recognizing it on sale. But deferral is not forgiveness: the built-in recapture liability carries into the replacement property’s basis and resurfaces (fully or partially, depending on any cash “boot” received) whenever you eventually sell without exchanging again. Depreciation recapture is also generally not eligible for installment-sale deferral under §453 — it is typically taxed in the year of sale even if the rest of the gain is spread over future payments.
§121 Never Shelters Recapture
The §121 home sale exclusion lets homeowners exclude up to $250,000 ($500,000 MFJ) of gain on a principal residence — but it explicitly does not reach depreciation claimed during any period the home was used as a rental. That unrecaptured §1250 gain remains taxable at the 25% cap even when the rest of the gain is fully excluded. If you converted a rental into your home before selling, expect a Form 4797/Schedule D worksheet bill on the depreciation years regardless of how much of the appreciation §121 shelters.
Reporting on Form 4797
Both regimes are reported on Form 4797, Sales of Business Property:
- Part III computes the ordinary-income recapture — full depreciation for §1245 property, any excess-over-straight-line depreciation for §1250 property (usually $0 for post-1986 buildings).
- The ordinary-income recapture amount flows to Form 1040, Schedule 1 as ordinary income.
- Remaining §1231 gain (equipment) or capital gain (real property) flows to Schedule D, where the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions isolates the 25%-capped slice for real property sellers and applies the correct rate through the Schedule D Tax Worksheet.
- Net §1231 gains for the year are subject to the 5-year “lookback” rule under §1231(c): any net §1231 gain is recharacterized as ordinary income to the extent of unrecaptured net §1231 losses claimed in the prior five years.
Mixed-Use Property — Don’t Treat It All as §1250
Most rental buildings aren’t purely §1250 real property. Appliances, carpeting, certain fixtures, and detachable equipment inside a rental are §1245 personal property even though they sit inside a §1250 building — and many owners depreciate them on separate MACRS schedules (5-year or 7-year) rather than the building’s 27.5-year (residential) or 39-year (nonresidential) straight-line schedule. A cost segregation study identifies these components up front.
The practical consequence at sale: the personal-property components carry uncapped §1245 recapture, while the structural shell carries the 25%-capped §1250 treatment. Lumping everything into one “real estate” bucket at sale can understate the ordinary-income portion of the tax bill if a meaningful share of depreciation was actually claimed on §1245 components.
State Tax Treatment
Most states piggyback on federal AGI or federal taxable income and inherit whatever recapture amount flows through — there is generally no separate state-level recapture calculation to perform once the federal Form 4797/Schedule D figures are set, though some states decouple from specific federal provisions and require an addback or subtraction (check your state’s conformity bulletin for the tax year of sale).
States with no personal income tax (Florida, Texas, Nevada, Washington, Tennessee, Alaska, South Dakota, Wyoming, New Hampshire) make the state-level question moot — only the federal recapture math above applies. States that tax income generally impose their own ordinary and capital gains rates (many don’t distinguish LTCG from ordinary income at the state level at all) on top of whatever the federal recapture and remaining-gain split produces.
Planning Takeaways
- Know your asset class before you price the deal. §1245 equipment recapture has no ceiling; §1250 real estate recapture is capped at 25%. The same depreciation total can produce a materially different tax bill depending on which bucket it falls in.
- Track adjusted basis precisely. Every dollar of depreciation you claimed reduces basis and increases recapture dollar-for-dollar on sale — the deduction and the recapture are two sides of the same transaction, separated only by time.
- Model NIIT alongside recapture, not as an afterthought — for investment property sellers it is close to automatic once MAGI clears the threshold.
- Consider §1031 for real property if you intend to keep investing in real estate — it defers recapture rather than eliminating it, so weigh the deferral against your exit timeline.
- Don’t assume converting a rental to a home shelters everything. §121 excludes appreciation, not depreciation. Budget for the unrecaptured §1250 gain tax separately.
Related Reading
- Rental property tax guide — depreciation schedules, basis tracking, and the mechanics that feed into recapture
- Section 179 depreciation guide — how accelerated deductions taken today translate into larger §1245 recapture on sale
- Passive activity loss rules for real estate investors — how suspended passive losses interact with the year you finally recognize recapture
- §121 home sale exclusion — why depreciation recapture survives even a fully excluded home sale gain
FAQs
Is depreciation recapture taxed as a capital gain or ordinary income?
It depends on the asset. §1245 recapture (equipment, machinery, personal property) is ordinary income with no rate cap. §1250 “unrecaptured gain” (real estate) stays inside the capital gains regime but is taxed at a special rate capped at 25% — higher than the standard 0/15/20% LTCG brackets, but generally lower than top ordinary rates.
Can depreciation recapture push me into a higher tax bracket?
Recapture is included in your income for bracket-stacking purposes even though it’s calculated with its own cap (for §1250) or full marginal rate (for §1245). It can push other ordinary income, or subsequent capital gains, into higher brackets by filling up the lower brackets first, and it counts toward MAGI for the NIIT threshold test.
Does 1031 exchange avoid depreciation recapture entirely?
No — it defers recognition, it does not forgive the liability. The recapture is built into the replacement property’s carryover basis and becomes taxable again (in full or in part) when you eventually sell without exchanging further, subject to boot received in the exchange.
What happens if I sell depreciated property at a loss?
There is no depreciation recapture if the sale produces no gain — recapture is capped at the lesser of depreciation taken or total gain realized. A sale below adjusted basis produces an ordinary or §1231 loss instead, with no recapture component.
Is unrecaptured §1250 gain the same thing as ordinary income recapture?
No. For real property placed in service after 1986 (straight-line MACRS required), there is typically no true ordinary-income §1250 recapture. “Unrecaptured §1250 gain” is a separate long-term capital gain category created by IRC §1(h) that taxes the depreciation-equivalent portion of your gain at up to 25% — a capital gains rate, just a higher one than the standard brackets.