Section 1250: Depreciation Recapture for Real Property Assets

Section 1250 property consists of depreciable real property, which includes buildings and their structural components but not land. For real estate investors, Section 1250 property encompasses residential rental buildings depreciated over 27.5 years, commercial buildings depreciated over 39 years, and structural elements such as foundations, framing, exterior walls, roof structures, and building systems that serve the structure as a whole.

The classification as Section 1250 property depends on the nature of the asset rather than its physical location. A component must be real property rather than personal property, meaning it must be permanently affixed to land or buildings and serve a structural function or general building purpose. Components that can be removed without damaging the structure or that serve specific uses rather than the building generally typically do not qualify as Section 1250 property.

After cost segregation analysis, the portion of building basis that remains in 27.5 or 39 year property classes continues to be Section 1250 property. If a commercial building has $2,000,000 original depreciable basis and cost segregation reclassifies $600,000 into shorter lived Section 1245 property classes, the remaining $1,400,000 stays as Section 1250 property depreciated over 39 years using the straight-line method.

Section 1250 property treatment creates more favorable recapture consequences than Section 1245 property because only the excess of accelerated depreciation over straight-line depreciation is recaptured as ordinary income. For buildings that must use straight-line depreciation under current law, this excess is zero, eliminating Section 1250 recapture exposure entirely. However, the accumulated straight-line depreciation still affects taxation through unrecaptured Section 1250 gain rules.

Section 1250 recapture rules require that the excess of actual accumulated depreciation over straight-line depreciation be recaptured as ordinary income when Section 1250 property is sold. The recapture amount equals the lesser of (1) the gain realized on sale, or (2) the excess accelerated depreciation. This mechanism prevents taxpayers from receiving the benefit of accelerated depreciation during ownership while paying only capital gains rates on disposition.

For most real property under current law, Section 1250 recapture is zero because buildings must be depreciated using straight-line methods. Residential rental property has been required to use straight-line depreciation since 1987, and nonresidential real property has faced the same requirement since 1993. When straight-line depreciation is used from inception, the excess of accelerated over straight-line is zero, producing zero Section 1250 recapture.

Section 1250 recapture can occur when property was originally depreciated using accelerated methods under pre-1987 or pre-1993 law and is sold today. The accumulated accelerated depreciation from earlier years exceeds what straight-line would have produced, creating recapture exposure. This scenario is increasingly rare as older properties become fully depreciated or are disposed of, but some long held properties still carry Section 1250 recapture exposure from historical accelerated depreciation.

The calculation of Section 1250 recapture requires determining what straight-line depreciation would have been if it had been used from the placed in service date. This hypothetical straight-line amount is compared to actual accumulated depreciation. The difference, limited to gain on sale, is Section 1250 recapture taxed at ordinary income rates. Any remaining gain attributable to straight-line depreciation becomes unrecaptured Section 1250 gain subject to a maximum 25% tax rate.

Unrecaptured Section 1250 gain is the portion of gain on sale attributable to straight-line depreciation previously claimed. While not technically depreciation recapture, unrecaptured Section 1250 gain receives less favorable tax treatment than long term capital gains. The maximum federal tax rate on unrecaptured Section 1250 gain is 25%, compared to 0%, 15%, or 20% rates for most long term capital gains depending on income level. For a broader overview of how these rates interact with cost segregation, see the depreciation recapture guide.

For buildings depreciated using straight-line methods from inception, all accumulated depreciation becomes unrecaptured Section 1250 gain to the extent of gain on sale. If a building cost $1,500,000, has $500,000 accumulated straight-line depreciation, and sells for $2,000,000, the first $500,000 of the $1,000,000 total gain is unrecaptured Section 1250 gain taxed at 25%. The remaining $500,000 of gain is capital gain taxed at preferential rates.

The unrecaptured Section 1250 gain calculation is limited to the total gain realized on sale. If accumulated depreciation exceeds total gain, the unrecaptured Section 1250 gain equals the total gain, not the full accumulated depreciation amount. If a building has $600,000 accumulated depreciation but only $400,000 total gain, the unrecaptured Section 1250 gain is $400,000. The remaining $200,000 of accumulated depreciation has already reduced basis and created gain, but there is no additional gain to tax.

Unrecaptured Section 1250 gain applies to both residential and commercial real property. The 25% maximum rate applies regardless of whether the property is a 27.5 year residential rental building or a 39 year commercial building. This consistent treatment across property types simplifies planning and creates predictable tax consequences for real estate dispositions. The rate differential between 25% unrecaptured Section 1250 gain and lower capital gains rates creates an incentive to minimize accumulated depreciation, but the time value of immediate deductions typically outweighs the future rate differential.

Section 1250 gain calculation involves determining the excess of actual accumulated depreciation over hypothetical straight-line depreciation, then limiting that excess to the total gain on sale. The formula is: Section 1250 recapture equals the lesser of (1) gain on sale, or (2) excess of accelerated depreciation over straight-line depreciation. For straight-line depreciated property, item (2) is zero, making Section 1250 recapture zero.

The calculation begins with determining actual accumulated depreciation from the property's depreciation schedules. Next, hypothetical straight-line depreciation is calculated based on the property's original basis, placed in service date, and applicable recovery period. The difference between actual and hypothetical straight-line is the excess accelerated depreciation. If actual equals straight-line, the excess is zero.

Once excess accelerated depreciation is determined, it is compared to total gain on sale. Gain on sale equals amount realized (sale price minus selling costs) less adjusted basis (original basis minus accumulated depreciation). The Section 1250 recapture amount is the lesser of excess accelerated depreciation or total gain. This limitation prevents recapture from exceeding the economic benefit received.

After Section 1250 recapture is calculated, remaining gain is further analyzed for unrecaptured Section 1250 gain and capital gain. Unrecaptured Section 1250 gain equals the lesser of (1) remaining gain after Section 1250 recapture, or (2) total straight-line depreciation. Any gain exceeding Section 1250 recapture plus unrecaptured Section 1250 gain is capital gain taxed at preferential rates. This layered approach ensures each category of gain receives its appropriate tax treatment.

Section 1250 property and cost segregation interact by reducing the amount of building basis classified as Section 1250 property. Without cost segregation, most building basis is Section 1250 property depreciated over 27.5 or 39 years. Cost segregation identifies components that qualify as Section 1245 property with shorter recovery periods, converting basis from Section 1250 treatment to Section 1245 treatment.

The reduction in Section 1250 property through cost segregation decreases the unrecaptured Section 1250 gain on disposition. If a $2,000,000 building remains entirely Section 1250 property, all accumulated depreciation creates unrecaptured Section 1250 gain taxed at 25%. If cost segregation reclassifies $600,000 into Section 1245 property, only the remaining $1,400,000 generates unrecaptured Section 1250 gain, while the $600,000 of reclassified components creates Section 1245 recapture taxed at ordinary rates.

This conversion creates a tradeoff between unrecaptured Section 1250 gain at 25% and Section 1245 recapture at ordinary income rates potentially reaching 37% federal. The higher recapture rate on Section 1245 components is accepted because the accelerated depreciation and bonus depreciation generate immediate tax savings whose present value exceeds the future incremental recapture cost. The time value of money makes current deductions at 37% more valuable than future taxes at 37%, especially over multi-year holding periods.

For properties where cost segregation identifies substantial amounts of personal property and land improvements, Section 1250 property may represent only 50% to 70% of original depreciable basis. This reduction substantially lowers the 25% unrecaptured Section 1250 gain on sale while increasing ordinary income recapture on Section 1245 components. The overall economic benefit depends on the magnitude of accelerated depreciation, holding period, and the differential between current and future marginal tax rates.

The impact of straight-line versus accelerated depreciation on Section 1250 recapture is fundamental to understanding real property disposition taxation. Buildings that use straight-line depreciation exclusively have zero Section 1250 recapture because there is no excess of actual depreciation over straight-line. Buildings that used accelerated methods in earlier years may have Section 1250 recapture equal to the accumulated excess accelerated depreciation.

Prior to 1987 for residential rental property and 1993 for nonresidential real property, taxpayers could elect accelerated depreciation methods that produced larger deductions in early years. When these properties are sold today, the historical excess of accelerated over straight-line depreciation creates Section 1250 recapture taxed as ordinary income. The amount decreases over time as the difference between accumulated accelerated and hypothetical straight-line narrows toward the end of the recovery period.

For properties placed in service under current law, the mandatory straight-line depreciation method eliminates Section 1250 recapture but does not eliminate the tax impact of accumulated depreciation. Instead, that impact appears as unrecaptured Section 1250 gain taxed at 25%. While this rate is higher than capital gains rates, it is substantially lower than ordinary income rates and represents a more favorable outcome than Section 1245 recapture on personal property.

The straight-line requirement for buildings creates a structural advantage for Section 1250 property relative to Section 1245 property when evaluating disposition consequences. Accumulated depreciation on Section 1250 property faces a maximum 25% rate through unrecaptured Section 1250 gain treatment, while accumulated depreciation on Section 1245 property faces full ordinary income recapture at rates up to 37%. This 12 percentage point differential partially offsets the value of accelerated depreciation on Section 1245 components, though the time value of money still favors immediate deductions even accounting for the higher recapture rate. To understand how this compares to personal property treatment, review Section 1245 depreciation recapture mechanics.

Section 1250 depreciation recapture tax rates depend on whether the recapture is excess accelerated depreciation or unrecaptured Section 1250 gain. Excess accelerated depreciation recaptured under Section 1250 is taxed as ordinary income at the taxpayer's marginal rate, which can reach 37% at the federal level plus applicable state taxes. For most properties under current law, this category is zero because straight-line depreciation is required.

Unrecaptured Section 1250 gain is taxed at a maximum 25% federal rate, creating a middle tier between ordinary income rates and preferential capital gains rates. This 25% rate applies to gain attributable to straight-line depreciation claimed on Section 1250 property. The rate is not graduated like capital gains rates, instead applying uniformly at 25% regardless of the taxpayer's income level, subject to the limitation that the rate cannot exceed the taxpayer's ordinary income rate. For a detailed breakdown of how these rates are applied in practice, see the depreciation recapture tax rate guide.

The effective Section 1250 recapture tax rate for most real estate sales combines the 25% unrecaptured Section 1250 gain rate with preferential capital gains rates on appreciation above original basis. If a building cost $1,000,000, has $300,000 accumulated depreciation, and sells for $1,400,000, the gain structure is: $300,000 unrecaptured Section 1250 gain at 25%, and $400,000 capital gain at 0%, 15%, or 20% depending on income. The blended rate depends on the proportion of depreciation recapture to total gain.

State tax treatment of Section 1250 recapture and unrecaptured Section 1250 gain varies by jurisdiction. Some states conform to federal treatment and apply higher rates to unrecaptured Section 1250 gain. Other states tax all long term capital gains uniformly without distinguishing unrecaptured Section 1250 gain. A few states have no income tax, eliminating state level taxation entirely. Property owners in high tax states may face combined federal and state rates exceeding 30% on unrecaptured Section 1250 gain, while those in no tax states pay only the 25% federal rate.

Section 1250 property examples include all types of depreciable real property used in business or investment. Residential rental buildings such as apartment complexes, single family rentals, and multifamily properties are Section 1250 property depreciated over 27.5 years. Commercial buildings including office buildings, retail centers, warehouses, and industrial facilities are Section 1250 property depreciated over 39 years.

Structural components that remain classified as real property after cost segregation analysis continue to be Section 1250 property. Foundations that support the building structure are Section 1250 property. Load bearing walls and structural framing are Section 1250 property. Roof structures (not roof coverings which may be reclassified) are Section 1250 property. Exterior walls, floor structures, and building envelope components are Section 1250 property when they serve structural rather than aesthetic functions.

Building systems that serve the structure as a whole rather than specific uses typically remain Section 1250 property. Central HVAC systems, primary electrical distribution systems, and main plumbing lines that serve the entire building are Section 1250 property. Fire suppression systems integrated into the building structure are Section 1250 property. Elevators and escalators, despite being mechanical equipment, are specifically excluded from Section 1245 treatment and remain Section 1250 property.

Examples of property that is not Section 1250 property include land, which is not depreciable, and components reclassified through cost segregation into Section 1245 property classes. Carpeting, appliances, removable fixtures, and decorative finishes are not Section 1250 property after reclassification. Land improvements such as parking lots, sidewalks, fencing, and landscaping are Section 1245 property rather than Section 1250 property despite being attached to land. Personal property used in the building operation but not permanently affixed is Section 1245 property.

Managing Section 1250 recapture involves strategic planning around depreciation methods, holding periods, disposition timing, and structural alternatives. For properties depreciated using straight-line methods under current law, Section 1250 recapture is already zero, but unrecaptured Section 1250 gain at 25% still applies to accumulated straight-line depreciation. Management strategies focus on deferring or eliminating this 25% gain through various techniques. For a comprehensive look at strategies that apply across both Section 1245 and Section 1250 recapture, see the guide on how to minimize depreciation recapture tax.

Like kind exchanges under Section 1031 defer both Section 1250 recapture and unrecaptured Section 1250 gain when real property is exchanged for like kind replacement property. The exchanged basis carries forward into the replacement property, and accumulated depreciation continues to exist for future recapture or unrecaptured gain taxation. Multiple serial exchanges can defer recognition indefinitely, pushing taxation to a final disposition or elimination through step up in basis at death.

Holding property until death provides a complete step up in basis under Section 1014, eliminating both Section 1250 recapture and unrecaptured Section 1250 gain. Heirs receive the property with a basis equal to fair market value at date of death, with no accumulated depreciation to recapture. This strategy requires the property to remain economically productive throughout the holding period and must be coordinated with estate tax planning to avoid exchanging income tax elimination for higher estate taxes.

Installment sales under Section 453 can spread Section 1250 recapture and unrecaptured Section 1250 gain over multiple years, potentially reducing overall tax rates by keeping the taxpayer in lower brackets. However, Section 1250 recapture (excess accelerated depreciation) must be recognized in full in the year of sale and cannot be deferred under installment sale rules. Only the unrecaptured Section 1250 gain and capital gain portions qualify for installment treatment, limiting the technique's effectiveness for most modern properties with zero Section 1250 recapture.

Section 1250 considerations should be integrated into comprehensive real estate disposition planning that evaluates total after tax proceeds rather than just pre-tax sale prices. The interaction between Section 1250 property treatment, Section 1245 recapture on cost segregated components, and capital gains taxation creates a complex tax structure that varies based on cost segregation implementation, holding period, and accumulated depreciation.

Properties with cost segregation typically have lower unrecaptured Section 1250 gain and higher Section 1245 recapture than properties without cost segregation. A building that would generate $600,000 of unrecaptured Section 1250 gain without cost segregation might generate only $350,000 of unrecaptured Section 1250 gain plus $250,000 of Section 1245 recapture after cost segregation. The tax difference is approximately $30,000 higher with cost segregation ($250,000 times 37% minus $250,000 times 25%), but the present value of years of accelerated depreciation typically exceeds this difference.

Disposition timing relative to depreciation recapture can influence net proceeds. Selling in a low income year when marginal tax rates are reduced can decrease the effective cost of both Section 1250 recapture and Section 1245 recapture. Conversely, selling in a high income year compounds the tax cost of recapture. Strategic timing around retirement, business sale transactions, or other income fluctuations can generate meaningful tax savings.

Alternative disposition structures such as sale to a related party, contribution to a partnership, or incorporation can modify Section 1250 recapture consequences. These transactions often involve complex tax rules and require careful planning to avoid triggering recapture prematurely or creating unintended tax consequences. Professional tax advice is essential when evaluating these alternatives to ensure compliance with Section 1250 rules and related provisions such as Section 707, Section 351, and related party transaction rules.