Section 1245 vs Section 1250 Recapture: The Difference

Section 1245 property is depreciable personal property — equipment, vehicles, furniture, machinery — and its recapture is taxed as ordinary income up to the full depreciation taken. Section 1250 property is depreciable real property — buildings and structural components — and its depreciation-related gain is taxed at a maximum 25 percent. The difference can be 12 percentage points of tax.

On this page

1. What is section 1245 property?
2. What is section 1250 property?
3. What is unrecaptured section 1250 gain?
4. Side by side
5. Where do the traps sit?
6. Worked example
7. Frequently asked questions
8. Related guides
9. Official sources
10. Next step

What is section 1245 property?

Section 1245 covers depreciable or amortizable property that is not a building or structural component: machinery, equipment, vehicles, furniture and fixtures, computers, tools, and also amortizable section 197 intangibles (goodwill, customer lists, covenants not to compete). It also picks up certain real property that received accelerated treatment — most importantly, building components that a cost segregation study reclassified as 5- or 7-year personal property, which are section 1245 property for recapture even though they are physically part of a building. Components reclassified as 15-year land improvements (paving, landscaping, fencing) remain section 1250 property.

The section 1245 rule: on sale, gain is ordinary income to the extent of all depreciation or amortization allowed or allowable (including section 179 and bonus depreciation). Gain above original cost is section 1231 gain, usually long-term capital gain.

What is section 1250 property?

Section 1250 covers depreciable real property that is not section 1245 property — buildings, structural components (walls, roofs, HVAC systems that serve the building, plumbing, electrical), and land improvements, including qualified improvement property. The section 1250 rule itself recaptures only "additional depreciation" — depreciation in excess of straight line. Because buildings placed in service after 1986 must use straight-line MACRS, section 1250 recapture in the strict sense is almost always zero for them. The exception is 1250 property that received bonus or 150 percent declining balance depreciation — land improvements and qualified improvement property — where the excess over straight line is "additional depreciation" and is recaptured as ordinary income.

What is unrecaptured section 1250 gain?

This is where the 25 percent rate comes from. For individuals, the portion of long-term capital gain on section 1250 property that is attributable to depreciation (and not already recaptured as ordinary income under section 1250 itself) is "unrecaptured section 1250 gain," taxed at a maximum rate of 25 percent rather than the 15 or 20 percent that applies to other long-term capital gains. It is reported on Schedule D's worksheet and Form 4797. For C corporations, a different rule (section 291) treats 20 percent of the straight-line depreciation (limited to the gain) as ordinary income instead.

Side by side

Where do the traps sit?

Cost segregation moves components from section 1250 to section 1245. A study that reclassifies US$300,000 of a building into 5- and 7-year property produces faster deductions — and converts that US$300,000 of future recapture from 25 percent-capped gain into ordinary income. For an owner who will sell within a decade, the study's benefit is the time value of the acceleration, offset by the higher rate on the way out; for an owner who holds for decades or dies owning the building (basis stepped up, recapture eliminated), the study's benefit is close to permanent.

Bonus depreciation on qualified improvement property and 15-year land improvements works differently: they remain section 1250 property, but bonus is "additional depreciation," so the excess over straight line is recaptured as ordinary income on sale and only the straight-line portion is unrecaptured section 1250 gain at up to 25 percent.

The "allowable" rule bites both sections equally: depreciation you were entitled to take reduces basis whether or not you claimed it. An owner who never depreciated a building still has unrecaptured section 1250 gain on sale, measured by the depreciation that was allowable, and has lost the deductions permanently unless an accounting-method change (Form 3115) recovers them.

Worked example

An investor sells a small commercial building after twelve years. Original cost US$900,000 (US$200,000 land). A cost segregation study in year one had reclassified US$180,000 of the building into 5- and 7-year property, all now fully depreciated; straight-line depreciation on the remaining US$520,000 of building over twelve years: US$160,000. Sale price: US$1.3 million. Total gain: US$1.3 million less adjusted basis (US$900,000 − US$160,000 − US$180,000 = US$560,000) = US$740,000. Of that: US$180,000 is section 1245 recapture (the cost-segregated components) — ordinary income; US$160,000 is unrecaptured section 1250 gain — maximum 25 percent; US$400,000 is long-term capital gain — 15 or 20 percent. Without the cost segregation study, the US$180,000 would have been depreciated more slowly over 39 years and, to the extent taken, taxed at 25 percent rather than ordinary rates on sale.

Frequently asked questions

Official sources

Publication 544 states: “Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property.” — Internal Revenue Service, Publication 544, Sales and Other Dispositions of Assets, https://www.irs.gov/publications/p544

Next step

Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles sale-of-asset planning, recapture characterization on Form 4797, cost segregation trade-off analysis, and like-kind exchange coordination. See pricing or book a call.