Section 1245 recapture

The Section 1245 recapture rule requires that gains on the sale of depreciable personal property—equipment, machinery, vehicles, and furniture—be taxed at ordinary income tax rates (up to 37% federally) to the extent of depreciation deductions taken. This contrasts with Section 1250 property (real estate) which has a preferential 25% rate. For business owners and investors in equipment-heavy operations, 1245 recapture can be the largest tax on a sale.

What is Section 1245 property?

1245 property includes most tangible personal property used in business:

• Equipment and machinery
• Vehicles (commercial)
• Furniture and fixtures
• Computers and technology
• Tools and implements

Real estate buildings are not 1245 property; they are Section 1250.

Depreciation schedules for 1245 property

1245 property has much shorter useful lives than real estate:

• 5-year property: Computers, office equipment, autos
• 7-year property: Most machinery and equipment
• 10-year property: Certain equipment and vessels
• 15-20-year property: Specialized equipment

Because the depreciable life is shorter, you write off the cost faster. This means larger depreciation deductions, larger adjustments to basis, and larger recapture amounts when you sell.

How 1245 recapture works

Suppose you buy equipment for $100,000 and depreciate it over 5 years using straight-line depreciation, taking $20,000 per year in deductions. After 5 years, your adjusted basis is $0.

You sell the equipment for $50,000. Your gain is $50,000 (sale price $50,000 minus adjusted basis $0). The entire $50,000 gain is 1245 recapture and is taxed at ordinary rates.

If you are in the 32% bracket, you owe $16,000 in federal tax on a $50,000 gain. This is far harsher than long-term capital gains treatment.

Bonus depreciation and accelerated depreciation

Bonus depreciation (and Section 179 expensing) allows you to write off the entire cost of 1245 property in the year of purchase. This creates an immediate tax deduction but also guarantees a full-amount 1245 recapture when you sell.

Example: Buy $100,000 equipment, deduct the full $100,000 under Section 179. Basis is now $0. Sell it ten years later for $80,000. The entire $80,000 gain is 1245 recapture, taxed at ordinary rates.

Recapture beyond depreciation

1245 recapture applies only to the extent of depreciation deductions taken. If your gain exceeds the depreciation you deducted, the excess is treated as a long-term capital gain (if held over one year) or short-term gain (if under one year).

Example: Buy equipment for $100,000; depreciate $50,000; sell for $120,000. Gain is $20,000. 1245 recapture is $20,000 (the full depreciation taken), taxed at ordinary rates. No excess gain.

If you sell for $150,000, gain is $50,000. 1245 recapture is $50,000 (depreciation deducted), taxed at ordinary rates. No additional gain.

If you sell for $160,000, gain is $60,000. 1245 recapture is $50,000 (depreciation deducted), taxed at ordinary rates. Excess gain of $10,000 is a long-term capital gain (if held over one year), taxed at preferential rates.

Interaction with holding period

If you hold 1245 property for over one year, the excess gain (beyond depreciation) is treated as a long-term capital gain. The recapture portion, however, is always at ordinary rates regardless of holding period.

Planning: Section 179 and recapture

Section 179 expensing allows you to immediately deduct the full cost of equipment. This saves tax in the year of purchase but triggers full recapture when you sell.

Whether to use Section 179 is a planning decision: front-load the tax benefit, or spread deductions over time? For short-lived equipment, Section 179 is usually optimal. For longer-held assets, the math is more complex.

See also