Section 1250 Recapture
Section 1250 Recapture is a tax provision under IRC Section 1250 and the unrecaptured Section 1250 gain rules that requires taxpayers who sell depreciable real property to pay a higher rate of tax on the portion of their gain attributable to previously claimed depreciation deductions, taxed at a maximum federal rate of 25% rather than the standard long-term capital gains rates.
When a taxpayer sells depreciable real estate at a gain, the federal tax rules bifurcate the gain into components taxed at different rates. The standard long-term capital gains rate (0%, 15%, or 20% depending on income) applies to the appreciation above original cost. But the portion of gain attributable to prior depreciation deductions — the amount by which the taxpayer reduced their adjusted basis through depreciation — is subject to the unrecaptured Section 1250 gain rules and taxed at a maximum rate of 25%.
The mechanics work as follows. A taxpayer buys a rental property for $500,000. Over ten years, they claim $150,000 in depreciation, reducing their adjusted basis to $350,000. They sell for $650,000. The total gain is $300,000 ($650,000 minus $350,000). The first $150,000 — equal to the depreciation claimed — is unrecaptured Section 1250 gain, taxed at up to 25%. The remaining $150,000 — the gain above the original purchase price — is taxed at the standard long-term capital gains rate.
The 25% rate is a cap, not a floor. A taxpayer in the 15% long-term capital gains bracket will pay 15% on unrecaptured Section 1250 gain because the cap only applies when the taxpayer would otherwise pay less. For high-income taxpayers in the 20% bracket plus the 3.8% Net Investment Income Tax under IRC Section 1411, the effective rate on unrecaptured gain can reach 28.8%.
Section 1250 technically requires recapture only of depreciation in excess of straight-line — a rule that, in practice, applies mainly to pre-MACRS property because MACRS already uses straight-line for real estate. However, the unrecaptured Section 1250 gain concept under the capital gains rate structure effectively captures all straight-line depreciation at the 25% rate, which is the practically important rule for modern real estate investors.
Bonus depreciation and accelerated cost segregation deductions amplify Section 1250 recapture exposure. A taxpayer who front-loads depreciation through cost segregation will face recapture on a larger amount of accumulated depreciation when the property eventually sells. Installment sales can spread the recapture income over multiple years, though the installment sale rules for recapture under IRC Section 453(i) require that all recapture income attributable to depreciation be reported in the year of sale regardless of when payments are received.