Depreciation Recapture

What is Depreciation Recapture?

Depreciation recapture is a federal tax rule that reclassifies some or all of the recognized gain from disposing of depreciable or amortizable property as ordinary income. It commonly applies when business or income-producing property is sold or otherwise disposed of for more than its adjusted tax basis.

Depreciation, amortization, Section 179 deductions, bonus depreciation, and other cost-recovery deductions generally reduce a property’s basis. 

Consequently, property can produce taxable gain even when it sells for less than its original cost.

The basic calculations are:

Adjusted basis = original basis + basis increases − basis reductions

Realized gain or loss = amount realized − adjusted basis

Depreciation recapture does not create additional gain. Instead, it determines how recognized gain is characterized for federal income-tax purposes. Depending on the property and transaction, gain may be treated as:

• Ordinary income under Section 1245

• Ordinary income under Section 1250

• Unrecaptured Section 1250 gain

• Gain treated under the Section 1231 rules

• Capital gain under another applicable rule

The general depreciation allowance is provided by IRC Section 167, while most modern tangible business and rental property is depreciated under the MACRS rules in IRC Section 168. The IRS guidance on sales and other dispositions of assets explains how depreciation affects the character of gain.

When Does Depreciation Recapture Apply?

A recapture calculation may be required when:

• Depreciable or qualifying amortizable property is sold or otherwise disposed of.

• Depreciation, amortization, Section 179, bonus depreciation, or another applicable cost-recovery deduction affects basis or recapture.

• The amount realized exceeds the property’s adjusted basis.

• The disposition produces recognized gain after applicable nonrecognition provisions are considered.

• Section 1245, Section 1250, or another recapture provision covers the property.

A conventional cash sale is not the only triggering event. Exchanges, involuntary conversions, part-sale and part-gift transfers, and other dispositions can require separate analysis.

What Property is Subject to Depreciation Recapture?

Property potentially subject to recapture includes:

• Machinery and equipment

• Business vehicles

• Computers and office equipment

• Furniture and fixtures

• Depreciable rental and commercial buildings

• Certain building components classified as Section 1245 property

• Certain specified amortizable property, including qualifying Section 197 intangibles and other property covered by Section 1245

• Qualified improvement property and other improvements, depending on their tax classification and deductions claimed

Certain qualified production property may be treated as Section 1245 property if it meets the statutory definition, is designated and elected under Section 168(n), and was placed in service after July 4, 2025. 

This is a specific statutory category; property does not qualify merely because it is used in production. CPA Pilot’s guide to Section 179, qualified production property, and other business-expensing changes provides related background.

A cost-segregation study does not automatically convert every identified building component into Section 1245 property. Classification depends on the asset’s function, permanency, relationship to the building, and applicable tax rules.

Land is not depreciable and therefore does not generate depreciation recapture.

Does Recapture Apply When Property is Sold at a Loss?

Depreciation recapture generally does not arise when the amount realized is below the property’s adjusted basis because there is no gain to recharacterize.

For example, equipment with an adjusted basis of $25,000 that is sold for $20,000 produces a $5,000 loss. The property’s use, classification, and holding period determine how that loss is treated.

A sale below original cost can still produce gain. The relevant comparison is between the amount realized and adjusted basis—not between the selling price and original purchase price.

What Does “Depreciation Allowed or Allowable” Mean?

“Allowed or allowable” generally requires a taxpayer to account for depreciation that was claimed or legally available, even when the full available deduction was not taken.

Failing to claim an available depreciation deduction does not ordinarily preserve the property’s original basis. The taxpayer may still need to reduce basis by the depreciation that should have been deducted.

Section 1245 contains a limited records-based qualification. If adequate records establish that the amount actually allowed for a period was less than the amount allowable, the allowed amount may control for that period when determining recomputed basis.

How is Depreciation Recapture Calculated?

A depreciation-recapture calculation first determines whether the disposition creates recognized gain. It then identifies the portion, if any, that must be treated as ordinary income.

Step 1: Determine the Original Tax Basis

Purchased property generally starts with its cost. Depending on the transaction, original basis can also include:

• Sales tax

• Freight and installation

• Legal and recording fees

• Certain settlement costs

• Other capitalized amounts required to acquire or place the property in service

Property received by gift, inheritance, exchange, or another nonpurchase transaction may begin with a different basis. TheIRS basis-of-assets rules explain how the acquisition method determines the starting basis.

Step 2: Calculate the Adjusted Tax Basis

Apply all required increases and reductions through the date of disposition:

Adjusted basis = original basis + basis increases − basis reductions

Capital improvements commonly increase basis. Reductions can include:

• Regular depreciation

• Amortization

• Section 179 deductions

• Bonus depreciation

• Certain credits

• Casualty-related adjustments

• Other applicable cost-recovery deductions

CPA Pilot’s tax basis and adjusted basis guide explains how basis changes during ownership. Its guide to bonus depreciation rules and elections provides additional information about accelerated cost recovery.

Step 3: Calculate the Amount Realized

The amount realized generally includes:

• Cash received

• Fair market value of property or services received

• Liabilities assumed by the buyer

• Debt from which the seller is discharged

Selling expenses generally reduce this amount:

Amount realized = total consideration received − selling expenses

If several assets are transferred in one transaction, the consideration and selling expenses must be allocated among those assets before calculating gain and recapture.

Step 4: Determine Realized and Recognized Gain

Calculate realized gain or loss as follows:

Realized gain or loss = amount realized − adjusted basis

Next, apply any recognition or nonrecognition rule affecting the transaction.

A taxable sale will often recognize the entire realized gain. A qualifying exchange or involuntary conversion may defer part of the gain, although separate recapture limitations can still require current recognition.

Step 5: Calculate Recapture and Classify the Remaining Gain

Apply the relevant recapture provision to the recognized gain attributable to each asset.

For qualifying trade-or-business property held for more than one year, gain remaining after ordinary-income recapture generally enters the Section 1231 framework. Section 1231 netting and lookback rules then determine its final character.

Depreciable property not used in a trade or business may still be subject to Section 1245 or Section 1250 recapture. Gain exceeding the recapture amount is generally reported under the capital-gain rules, subject to applicable holding-period and activity rules, instead of Section 1231.

What is the Difference Between Section 1245 & Section 1250 Recapture?

Section 1245 generally covers depreciable personal property and specified additional property. Section 1250 generally covers depreciable real property that is not and has never been Section 1245 property.

Each section uses a different method to determine ordinary-income recapture.

How Does Section 1245 Recapture Work?

Section 1245 property commonly includes:

• Machinery and equipment

• Business vehicles

• Computers and office equipment

• Furniture and fixtures

• Certain building components properly classified as Section 1245 property

• Certain specified amortizable property

• Qualified production property meeting the Section 168(n) statutory, designation, election, and placed-in-service requirements

In a straightforward, fully taxable disposition, Section 1245 ordinary-income recapture is commonly summarized as the lesser of:

1. The recognized gain attributable to the property; or

2. Applicable depreciation, amortization, Section 179, bonus depreciation, and related basis adjustments.

The statutory calculation uses recomputed basis and contains special rules for exchanges, involuntary conversions, gifts, transfers at death, and other dispositions.

How Does Section 1250 Recapture Work?

Section 1250 property generally includes depreciable buildings, structural components, and leasehold interests that are not Section 1245 property.

For Section 1250 property held for more than one year, ordinary-income recapture generally applies to “additional depreciation.” This can include:

• Depreciation exceeding the amount calculated under the straight-line method

• Certain special depreciation allowances

• Deductions resulting from other accelerated methods

• Other adjustments treated as additional depreciation under the applicable rules

Residential rental and nonresidential real property placed in service under modern MACRS rules is generally depreciated using a straight-line method. Therefore, an individual selling such property may have little or no true Section 1250 ordinary-income recapture if no special allowance or other additional depreciation applies.

For Section 1250 property held for one year or less, all applicable depreciation adjustments can be treated as additional depreciation rather than only the amount exceeding straight-line depreciation.

What is Unrecaptured Section 1250 Gain?

Unrecaptured Section 1250 gain is not ordinary-income recapture under Section 1250. It is generally long-term gain attributable to depreciation that was not already treated as ordinary income.

It cannot:

• Exceed the applicable net Section 1231 gain

• Include gain already characterized as ordinary income

• Exceed the depreciation-related gain otherwise eligible for the category

For individuals and other taxpayers subject to the federal capital-gain rate rules in Section 1(h), unrecaptured Section 1250 gain can be taxed at a maximum federal rate of 25%. The taxpayer’s actual federal rate may be lower.

The amount is determined after completing the applicable ordinary-income recapture and Section 1231 calculations.

How Does Section 291 Affect C Corporations?

A C corporation can recognize additional ordinary income under Section 291 when it disposes of certain Section 1250 property.

The additional amount is generally 20% of the excess of:

• The amount that would have been ordinary income if the property were Section 1245 property, over

• The amount treated as ordinary income under Section 1250.

This rule can apply even when an individual using straight-line depreciation would have little or no true Section 1250 ordinary-income recapture.

Section 1245 vs. Section 1250 Comparison

How Does Depreciation Recapture Work on Rental Property?

A rental-property disposition requires separate analysis of the building, land, and any independently classified assets.

The building’s depreciation history determines its potential Section 1250 treatment. Assets separated from the building, such as qualifying equipment or personal-property components, may require a Section 1245 calculation.

Rental-Property Depreciation Recapture Example

Assume an individual owns residential rental property with the following tax history:

The property is sold for $650,000 with $30,000 of selling expenses. Assume relative fair market values support an 80% allocation to the building and a 20% allocation to the land.

Assume further that:

• The building was held for more than one year.

• All building depreciation was calculated using a straight-line method.

• No bonus depreciation, special depreciation allowance, or other additional depreciation applies.

• The rental property qualifies as trade-or-business property under Section 1231.

• The owner is not a C corporation subject to Section 291.

• No prior Section 1231 losses affect the result.

• Relative fair market values support the allocation.

Under those assumptions, the transaction may produce:

• No ordinary-income Section 1250 recapture

• Up to $120,000 of unrecaptured Section 1250 gain

• $120,000 of additional gain potentially entering the Section 1231 framework

This example illustrates the broad character of the gain rather than the taxpayer’s final liability. Section 1231 netting, the five-year lookback rule, passive-activity rules, net investment income tax, entity classification, and other transaction-specific provisions can alter the result.

How Are the Sale Price & Expenses Allocated Between Land & Building?

When land and depreciable property are transferred in the same transaction, the selling price and selling expenses must be allocated according to their respective fair market values.

A historical purchase-price allocation does not automatically establish the proper disposition-date allocation. A current appraisal, assessed values, or other credible valuation evidence may be necessary.

Allocation is required because:

• Land and buildings have separate adjusted bases.

• Only the building carries a depreciation history.

• Separately classified assets can have different recapture calculations.

• Total transaction gain cannot identify the gain attributable to each asset.

The Form 4797 instructions for land and depreciable property require the transaction to be allocated among the applicable assets.

How is Gain Remaining After the Real-Estate Depreciation Component Treated?

For rental property used in a trade or business and held for more than one year, gain remaining after applicable recapture generally enters the Section 1231 framework. Whether a rental activity constitutes a trade or business depends on the facts, including the nature and extent of the taxpayer’s activity.

After qualifying Section 1231 items are combined:

• A net Section 1231 gain may receive long-term capital-gain treatment.

• A net Section 1231 loss is generally treated as an ordinary loss.

• The five-year lookback rule can recharacterize current net gain as ordinary income to the extent of applicable nonrecaptured Section 1231 losses from the preceding five years.

Rental property that does not satisfy the trade-or-business requirements does not automatically qualify for Section 1231 treatment.

How is Depreciation Recapture Reported on Form 4797?

Form 4797, Sales of Business Property, is the principal federal form used to calculate Section 1245 and Section 1250 ordinary-income recapture.

The reporting path depends on the property’s use, classification, holding period, and disposition result.

Property Held for More Than One Year

For depreciable trade-or-business property held for more than one year and sold at a gain, Part III of Form 4797 is generally used to calculate the applicable Section 1245 or Section 1250 recapture.

Part III reports information such as:

• Property description

• Acquisition and disposition dates

• Gross sales price

• Cost or other basis

• Depreciation and amortization

• Adjusted basis

• Total gain

• Ordinary-income recapture

Any remaining qualifying Section 1231 gain is then reported through Part I.

A loss on comparable property generally follows the applicable Part I reporting path rather than Part III’s gain-recapture computation.

Property Held for One Year or Less

Gain or loss from depreciable trade-or-business property held for one year or less is generally reported in Form 4797 Part II and treated as ordinary.

The exact reporting path can vary according to the property and transaction, so the current form instructions control.

Depreciable Investment or Not-for-Profit Property

Depreciable property not used in a trade or business can still be subject to Section 1245 or Section 1250 recapture.

The recapture amount is generally calculated in Form 4797 Part III. Gain exceeding that amount is generally reported under the capital-gain rules on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, subject to applicable holding-period and activity rules.

The excess does not automatically enter the Section 1231 calculation.

An installment sale may also require Form 6252. A qualifying like-kind exchange may require Form 8824.

Depreciation Recapture FAQs

Does Gifting Depreciated Property Trigger Depreciation Recapture?

A gift generally does not trigger Sections 1245 or 1250 recapture. The recipient usually takes a carryover basis and considers the donor’s depreciation history when later disposing of the property.

Does Inherited Property Retain Depreciation Recapture?

A transfer at death generally does not trigger recapture. The heir’s basis and future tax result depend on estate-basis rules, ownership structure, and any income-in-respect-of-a-decedent exception.

Does the Home-Sale Exclusion Cover Depreciation Recapture?

No. Section 121 generally cannot exclude gain attributable to depreciation allowed or allowable after May 6, 1997. Rental or home-office use may leave taxable depreciation-related gain.

Can Suspended Passive Losses Offset Depreciation Recapture?

A fully taxable sale to an unrelated person may release suspended passive losses under Section 469. Their release does not change recapture’s character; ordering and activity rules determine the offset.

Does Selling a Partnership Interest Create Depreciation Recapture Income?

It can. A partnership-interest sale may produce ordinary income under Section 751 and unrecaptured Section 1250 gain based on underlying assets. The partnership may also have Form 8308 reporting duties.