Depreciation recapture is the rule that changes the character of gain on the disposition of depreciable property, treating part or all of the gain as ordinary income rather than capital gain, because depreciation had already reduced the property’s basis. It is not a separate tax and it is not a clawback of the deductions themselves. Two Code sections carry almost all of the work, they do not reach equally far, and which one applies turns on what the property is.
The general statement is the IRS’s own. If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain, even if otherwise nontaxable, as ordinary income (IRS, Publication 544 (2025)).
The basis that recapture works from is the one built in fixed assets and drawn down by whatever depreciation was allowed or allowable on the asset, of which straight line depreciation is one method among several. Recapture does nothing to that schedule while the asset is in service. It only decides how the gain is taxed on the way out.
Section 1245 Reaches All of the Depreciation
For section 1245 property, the ordinary income is the amount by which the lower of the recomputed basis of the property or, in the case of a sale, exchange or involuntary conversion, the amount realized, exceeds the adjusted basis of the property. For any other disposition, fair market value stands in for the amount realized (26 U.S.C. 1245(a)(1)).
Recomputed basis is the term carrying the weight. It means the property’s adjusted basis recomputed by adding back all adjustments reflected in that adjusted basis on account of deductions, whether in respect of the same or other property, allowed or allowable to the taxpayer or to any other person for depreciation or amortization (26 U.S.C. 1245(a)(2)(A)).
Stated the way the IRS states it, the ordinary income is the lesser of the depreciation and amortization allowed or allowable on the property, or the gain realized on the disposition. Any gain recognized above that ordinary income part is section 1231 gain (IRS, Publication 544 (2025)), whose character is settled by netting across the whole year rather than asset by asset, as capital assets sets out.
The property class is narrower than the phrase depreciable property suggests. Section 1245 property is property that is or has been subject to an allowance for depreciation or amortization and is personal property, or other tangible property except buildings and their structural components used as an integral part of activities such as manufacturing, production or extraction, along with several narrower categories. The term structural component includes walls, floors, windows, doors, central air conditioning systems and light fixtures, and buildings and structural components are excluded unless they are qualified production property (IRS, Publication 544 (2025)).
Section 1250 Reaches Only Additional Depreciation
Section 1250 property is all real property subject to an allowance for depreciation that is not and never has been section 1245 property (IRS, Publication 544 (2025)).
For that property the ordinary income is the applicable percentage of the lower of the additional depreciation attributable to periods after December 31, 1975, or the excess of the amount realized over the adjusted basis. For all other section 1250 property, meaning everything outside a short list of subsidized and rehabilitated housing categories, the applicable percentage is 100 percent (26 U.S.C. 1250(a)(1)(A) and (a)(1)(B)(v)).
Additional depreciation is where the two regimes part. In the case of property held more than one year it means the depreciation adjustments only to the extent that they exceed the amount of the adjustments which would have resulted if they had been determined for each taxable year under the straight line method (26 U.S.C. 1250(b)(1)). If the property is held for one year or less, all the depreciation is additional depreciation (IRS, Publication 544 (2025)).
So a building depreciated on the straight line method produces no additional depreciation, and with it no section 1250 ordinary recapture. The IRS gives four conditions and any one of them is enough. The one that covers a modern building is that the property was residential rental property or nonresidential real property placed in service after 1986, or after July 31, 1986 if the choice to use MACRS was made, you held it longer than one year, and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. If the property was in a renewal community, you must also not have elected to claim a commercial revitalization deduction (IRS, Publication 544 (2025)).
The tax form says it in a single line, exception included. In the section 1250 block of Form 4797, if straight line depreciation was used, you enter -0- on line 26g, except for a corporation subject to section 291 (IRS, Form 4797 (2025)).
That exception is a real amount, not a formality, and it is the reason a corporate seller and an individual seller of the same building do not get the same answer. In the case of section 1250 property which is disposed of during the taxable year, 20 percent of the excess of the amount which would be treated as ordinary income if such property was section 1245 property, over the amount treated as ordinary income under section 1250 determined without regard to that paragraph, is treated as gain which is ordinary income under section 1250 (26 U.S.C. 291(a)(1)). So a corporation subject to that section still reports ordinary income on a straight line building where an individual reports none.
Which parts of a building are section 1245 property rather than section 1250 property, and what that classification costs at the exit, is worked through in commercial real estate accounting.
Unrecaptured Section 1250 Gain Is a Rate Ceiling, Not Recapture
The two are easy to swap and they are not the same thing. Unrecaptured section 1250 gain is not ordinary income and it is not section 1250 recapture. It is long-term capital gain that carries a maximum rate of its own.
For an individual, the maximum capital gains rate schedule applies 25 percent to unrecaptured section 1250 gain, subject to the ordering rules in that same paragraph (26 U.S.C. 1(h)(1)(E)).
The term itself is defined by a hypothetical, which is why it reads so oddly. It means the excess of the amount of long-term capital gain, not otherwise treated as ordinary income, which would be treated as ordinary income if section 1250(b)(1) included all depreciation and the applicable percentage under section 1250(a) were 100 percent, over a netting amount defined in the same subsection (26 U.S.C. 1(h)(6)(A)).
Plainly stated, it is the part of any long-term capital gain on section 1250 property, meaning real property, that is due to depreciation, and it cannot be more than the net section 1231 gain or include any gain otherwise treated as ordinary income. It is figured on the Unrecaptured Section 1250 Gain Worksheet in the Instructions for Schedule D (Form 1040) (IRS, Publication 544 (2025)).
That rate sits inside the capital gains schedule rather than beside it. For 2025 the maximum capital gains rates for individuals are 0%, 15%, 20%, 25%, and 28% (IRS, Publication 544 (2025)). Real property held on the straight line method leaves the depreciation-driven part of the gain in the capital column, and this is the rate that meets it there.
Allowed or Allowable Is the Trap
Basis comes down by the depreciation that could have been claimed, not only by the depreciation that was claimed. Proper adjustment is made for exhaustion, wear and tear, obsolescence, amortization and depletion to the extent allowed as deductions, but not less than the amount allowable, and where no method has been adopted under section 167 the amount allowable is determined under the straight line method (26 U.S.C. 1016(a)(2)).
The same standard runs through the recapture computation. The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income, and if you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method (IRS, Publication 544 (2025)).
There are two reliefs and both are narrow. If in prior years proper deductions were consistently taken under one method, the amount allowed for those prior years will not be increased even though a greater amount would have been allowed under another proper method, and the IRS confines that treatment to figuring what part of gain is treated as ordinary income under the section 1245 depreciation recapture rules (IRS, Publication 544 (2025)). The statute supplies the other: if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed for any period was less than the amount allowable, the amount added back for that period is the amount allowed (26 U.S.C. 1245(a)(2)(B)).
A Worked Example on Section 1245 Property
Say a client sells a machine that has sat on the depreciation schedule for several years, and the price is above what the machine originally cost.
Cost 50,000
Depreciation allowed or allowable 30,000
Adjusted basis 50,000 - 30,000 = 20,000
Amount realized 56,000
Total gain 56,000 - 20,000 = 36,000
Ordinary income, the lesser of
the depreciation and the gain 30,000
Remaining gain 36,000 - 30,000 = 6,000The ordinary income stops at the depreciation. What is left, the part of the price above original cost, is not recapture at all, and on business property held longer than one year it is section 1231 gain (IRS, Publication 544 (2025)). Change one input and the shape changes: sell the same machine above its adjusted basis but below its original cost and the whole gain is ordinary, because the depreciation is larger than the gain.
Where It Lands on the Return
Recapture is computed in Part III of Form 4797, headed Gain From Disposition of Property Under Sections 1245, 1250, 1252, 1254, and 1255. Line 22 of that part is captioned Depreciation (or depletion) allowed or allowable, line 25b carries the section 1245 amount and line 26g the section 1250 amount (IRS, Form 4797 (2025)).
The totals then split in two directions. Line 31 adds the recapture amounts across the properties and is entered on line 13, inside Part II, Ordinary Gains and Losses. Line 32 subtracts line 31 from the total gains on line 30, and the portion from other than casualty or theft goes to line 6, inside Part I (IRS, Form 4797 (2025)).
Part I is where the capital treatment appears. For individuals, partners, S corporation shareholders and all others, if line 7 is a gain and there were no prior year section 1231 losses, or they were recaptured in an earlier year, the gain from line 7 is entered as a long-term capital gain on the Schedule D filed with the return (IRS, Form 4797 (2025)).
One disposition therefore leaves the form along two paths and lands in two different places on the return. That split is the practical reason the depreciation column on a fixed asset schedule has to be right years before anyone sells anything.
What Is the Depreciation Recapture Rule?
It is a lesser-of rule with a priority clause attached. Under both sections the ordinary income is capped by the gain actually realized and by the depreciation that the section reaches, and the statute then directs that such gain shall be recognized notwithstanding any other provision of this subtitle (26 U.S.C. 1245(a)(1) and 26 U.S.C. 1250(a)(1)(A)). That closing clause is why recapture can surface inside a transaction the taxpayer expected to be tax free.
How Do I Avoid Paying Depreciation Recapture?
The Code names the dispositions it does not reach rather than leaving the answer to planning. Section 1245 does not apply to a disposition by gift, and, except as provided in section 691 for income in respect of a decedent, it does not apply to a transfer at death. Where gain is not recognized in whole or in part under section 1031 or 1033, the gain taken into account is limited to the gain recognized on the disposition plus the fair market value of property acquired which is not section 1245 property and is not already counted in that recognized gain (26 U.S.C. 1245(b)(1), (b)(2) and (b)(4)).
Some of that is deferral rather than escape, and the difference is worth saying out loud to a client. On a gift, if the donee later sells in a disposition subject to recapture, the donee must take into account the depreciation the donor deducted in figuring the gain to be reported as ordinary income. The installment method does not spread it either, because recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale, even if no payments are received in that year (IRS, Publication 544 (2025)).
Is Depreciation Recapture Always 25%?
No, and the question is really three things wearing one name. Section 1245 recapture is ordinary income, so no capital gains rate reaches it (26 U.S.C. 1245(a)(1)). Section 1250 ordinary recapture applies only to additional depreciation, which is commonly nil on real property held on the straight line method (26 U.S.C. 1250(b)(1)), though a corporation subject to section 291 still picks up 20 percent of the excess of what would have been ordinary income if the property were section 1245 property over the amount already ordinary under section 1250 (26 U.S.C. 291(a)(1)). The 25 percent belongs to the third thing, unrecaptured section 1250 gain, which stays capital gain and takes that rate as a ceiling on an individual’s return (26 U.S.C. 1(h)(1)(E) and 1(h)(6)).
What Happens When You Sell a Fully Depreciated Property?
Adjusted basis is at or near zero, so nearly the whole amount realized is gain, and on section 1245 property the recapture reaches all of it up to the depreciation taken. The harder version of the question is the asset nobody ever depreciated. Basis is still reduced by not less than the amount allowable (26 U.S.C. 1016(a)(2)), so the gain arrives anyway, and the permanent records that have to support it are the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis (IRS, Publication 544 (2025)).
If disposition workpapers and fixed asset schedules are the work that slips when a firm is short on capacity, a trial task puts a block of that work through Accountably’s review chain before any live file depends on it.
