Unrecaptured Section 1250 Gain

The unrecaptured Section 1250 gain is the portion of a real estate sale profit equal to cumulative straight-line depreciation deductions taken during ownership, taxed at a preferential 25% federal rate rather than ordinary income rates. It exists because depreciation reduces basis (and thus ordinary income) during the hold; when the property appreciates anyway and sells, the tax code recaptures that benefit at a higher rate than ordinary capital gains but lower than ordinary income.

The logic: getting back the tax benefit you received

When you buy a rental property for $500,000 and claim $20,000 in depreciation the first year, you reduce your taxable income by $20,000, saving perhaps $4,500–$6,500 in federal tax depending on your marginal rate. The IRS allowed that deduction as an incentive for investment in real property.

But depreciation is a timing tool, not a forgiveness tool. If the property appreciates and you sell for $550,000 after claiming $100,000 total in depreciation deductions over ten years, the IRS wants to recapture the benefit. The gain is $50,000 ($550,000 sale price minus $500,000 original basis). But you have already used depreciation to reduce taxable income by $100,000—a benefit you would not have received if the property had fallen in value.

To recoup some of that foregone tax, the IRS taxes the depreciation portion of the gain (unrecaptured Section 1250 gain) at 25%, a rate higher than the preferential 15%–20% long-term capital gains rates but lower than ordinary income brackets (which can reach 37% federally). This is the compromise: depreciation is deductible at favorable ordinary-income rates, but its recapture is taxed at a middle rate.

How the mechanics work: step-by-step

Scenario: You purchase a rental building (not land, which does not depreciate) for $400,000 in 2015. The IRS assigns a 27.5-year depreciation life to residential real estate. You claim straight-line depreciation of approximately $14,545 per year. After eight years (2023), you have claimed $116,360 in cumulative depreciation. Your adjusted basis is $400,000 − $116,360 = $283,640.

You sell in 2023 for $500,000. The total gain is $500,000 − $283,640 = $216,360.

Breaking down the gain:

• Unrecaptured Section 1250 gain (prior depreciation): $116,360
• Remaining long-term capital gain (appreciation net of depreciation): $100,000

Tax calculation:

• Unrecaptured 1250 gain: $116,360 × 25% = $29,090
• Remaining capital gain: $100,000 × 15% or 20% (depending on income) = $15,000 or $20,000
• Total federal tax on the sale: $44,090–$49,090

If the entire gain had been taxed at ordinary rates (say, 32% marginal rate), the federal tax would have been $216,360 × 32% = $69,237. The preferential Section 1250 rate saved you approximately $20,000 in federal tax—a meaningful benefit.

Why straight-line matters: accelerated depreciation gets ordinary rates

Not all depreciation recapture is taxed at 25%. If you used accelerated depreciation (e.g., cost recovery deductions for commercial property under MACRS with short lives), that accelerated portion is recaptured at ordinary income rates—potentially as high as 37%. The 25% rate applies only to the portion attributable to straight-line depreciation.

For most real estate held more than one year:

• Residential rental property uses a mandatory straight-line 27.5-year life, so all depreciation is eligible for the 25% rate.
• Commercial real estate and certain other real property are depreciated over 39 years, also straight-line, so recapture is at 25%.
• Personal property (e.g., equipment, furniture within a building) may be depreciated using accelerated methods, with recapture at ordinary rates.

This distinction matters little for residential landlords but can materially affect commercial developers.

The cost-basis perspective: it is not actually a “loss” of benefit

A common misunderstanding: investors resent paying 25% on depreciation recapture, viewing it as the IRS taking back the deduction. Technically, the IRS did not take it back—you received it, in full, in the years you claimed it. The 25% tax is simply the bill coming due.

To see why: if you claim $100,000 in depreciation over ten years at a 32% marginal rate, you save approximately $32,000 in taxes immediately. If you later pay 25% recapture on that same $100,000 ($25,000 in tax), your net tax benefit over the entire cycle is $32,000 − $25,000 = $7,000. That is a real advantage compared to paying 32% on the appreciation all along.

Conversely, if the property declines in value and you never sell, you keep the depreciation deduction forever with no recapture—a pure benefit. Recapture only arises if the property appreciates (and you sell).

Offsetting losses and negative net gains

If you claim $100,000 in cumulative depreciation but sell at a loss (sale price below adjusted basis), there is no Section 1250 recapture. The depreciation deductions you claimed do reduce your basis, so the loss is smaller than it would have been; but there is no separate recapture tax.

Similarly, if your total gain is $50,000 but you have claimed $100,000 in depreciation, the gain is limited to $50,000. You do not “recapture” $100,000; you recapture only the gain that exists.

If you have depreciation of $100,000 and a loss of $30,000, there is no taxable gain and no Section 1250 recapture. The loss carries forward or offsets other gains.

Interaction with alternative minimum tax

For high-income individuals subject to alternative-minimum-tax (AMT), Section 1250 recapture can push income above the AMT threshold, triggering additional tax. This is one reason some high-net-worth real estate investors pay attention to realizing gains in years where other income is depressed.

Interaction with depreciation-recapture-investor rules

If you are a real estate professional, all of your depreciation deductions remain ordinary deductions during the hold period. The recapture rate does not change—unrecaptured 1250 gain is still taxed at 25% on sale, regardless of whether you qualified as a professional. The professional designation simply allows you to deduct unlimited losses against active income; it does not affect the recapture rate.

Estate and gifting scenarios

If you die while holding real estate, your heirs receive a step-up in basis to fair market value as of the date of death. All accumulated depreciation recapture disappears forever. Your heirs can depreciate the property afresh from the stepped-up basis, and if they later sell, only their post-inheritance depreciation is subject to Section 1250 recapture.

This is one reason some investors hold appreciated rental real estate until death rather than selling: the 25% recapture (and potentially higher capital-gains taxes) never materialize. Of course, this assumes the property is held long enough that deferral is worth the opportunity cost.

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