Section 1250 recapture

The Section 1250 recapture rule applies to depreciation deductions taken on real estate. When you sell a rental property or commercial building, gains attributable to depreciation are taxed at a preferential 25% federal rate (for straight-line depreciation on residential real estate) rather than ordinary income tax rates up to 37%. This is a major advantage of real estate investment—the recapture rate is capped at 25%, often lower than long-term capital gains for the wealthiest investors.

What is Section 1250 property?

1250 property is real estate: rental apartments, office buildings, warehouses, retail spaces, and other commercial buildings. Land itself is not 1250 property; only the building structure qualifies for depreciation.

Residential real estate is depreciated over 27.5 years; commercial real estate over 39 years. These long lives mean that depreciation deductions are modest relative to the property’s value, but over decades they accumulate.

The 25% rate

Here is the key advantage: 1250 property has a 25% recapture rate, capped by statute. This is far better than:

• Ordinary income tax rates (up to 37%) for Section 1245 property
• Ordinary rates for many investors’ short-term capital gains

Moreover, 25% is competitive with or better than long-term capital gains rates for the wealthiest investors (who pay 20% federal plus the 3.8% net investment income tax = 23.8%).

This is by design: Congress encourages real estate investment by capping the recapture rate.

How 1250 recapture works

Suppose you buy a rental property for $400,000 (land $80,000, building $320,000). You depreciate the building at $11,636 per year (straight-line over 27.5 years). After 20 years, you have taken $232,720 in depreciation deductions.

Your adjusted basis is now $400,000 - $232,720 = $167,280. You sell for $550,000.

Your total gain is $550,000 - $167,280 = $382,720. That breaks down as:

• 1250 recapture: $232,720 (depreciation taken), taxed at 25% = $58,180 tax
• Remaining gain: $150,000 (appreciation beyond depreciation), taxed at long-term capital gains rates = $0-$30,000 tax

The recapture portion is always 25%, regardless of your income tax bracket.

Straight-line vs. accelerated depreciation

If you use straight-line depreciation (spreading the deduction evenly), 1250 gains are taxed at 25%.

If you use accelerated depreciation (deducting more in early years), the excess accelerated portion may be recaptured at ordinary rates (up to 37%), not 25%. However, modern tax law generally limits accelerated depreciation; residential real estate must use straight-line depreciation.

Land is never recaptured

Land does not depreciate (except in rare geological circumstances). So the portion of your purchase price allocated to land is never subject to recapture. If your property is 80% building and 20% land, only the 80% can recapture. The 20% carries forward as ordinary basis.

Avoiding recapture: 1031 exchange

A 1031-like-kind exchange allows you to sell rental property and buy similar property, deferring all capital gains and 1250 recapture indefinitely. This is the primary tool investors use to manage real estate recapture.

Recapture is deferred, not eliminated. When you eventually sell without another exchange, recapture comes due.

Step-up at death

If a rental property is inherited, heirs receive a step-up in basis to fair market value at the date of death. All embedded 1250 recapture is erased. This is why holding appreciated rental property until death is often the most tax-efficient approach.

State and local tax

The 25% federal rate does not include state and local taxes. Many states tax 1250 gains at ordinary rates or have separate real estate gains taxes. The all-in recapture rate can exceed 30-40% including state taxes.

Comparison to Section 1245

Real estate is far more tax-efficient than equipment because 1250 rates are capped.

See also