Unrecaptured Section 1250 Gain

An unrecaptured Section 1250 gain is a portion of your capital gain on real property, taxed at a preferential but higher rate (25%) to recapture the tax benefits you claimed from depreciation deductions while you owned the property. It applies almost exclusively to real estate.

The depreciation and recapture framework

When you own residential real estate or commercial real estate, the IRS allows you to deduct a portion of the building’s cost each year as depreciation, even though the building may be appreciating in market value. These deductions reduce your taxable income while you own the property.

When you sell, the IRS wants some of those tax savings back. It does this by “recapturing” the depreciation—treating it as ordinary income at your full marginal rate—or, under Section 1250, at a preferential 25% rate if you hold the property long-term. This is the unrecaptured Section 1250 gain.

How it works: a concrete example

Suppose you buy a rental house for $500,000. You depreciate it at $10,000 per year for 10 years, deducting $100,000 total. During that time, your taxable income from the property is reduced by $100,000, saving you taxes.

Now you sell the house for $700,000. Your total capital gain is $200,000 ($700,000 sale price minus $500,000 cost basis). But here’s the split:

• $100,000 of gain is the unrecaptured Section 1250 gain (the depreciation you reclaimed). This is taxed at 25%.
• $100,000 of gain is regular long-term capital gain, taxed at the normal preferential rate (0%, 15%, or 20% depending on income).

The result is a blended rate on your total gain—higher than you’d pay on stock appreciation, but lower than ordinary income rates.

Why 25% and not 20%?

The 25% rate sits between long-term capital gains (0–20%) and short-term gains (ordinary rates of up to 37%). It reflects a legislative compromise: the IRS allows you to claim depreciation deductions (which are valuable), but when you realize the gain, it recaptures some of that value at a moderately high rate.

This rate has been in place since the Tax Reform Act of 1986 and has survived subsequent tax overhauls, indicating broad consensus that depreciation recapture deserves different treatment than pure asset appreciation.

What qualifies as Section 1250 property

Section 1250 property is real property that is not section 1245 property (which includes most personal property and machinery). For real estate, depreciation taken after 1986 on the “straight-line” method qualifies for the 25% rate. Accelerated depreciation on real property, if allowed, would be recaptured at ordinary rates—a disincentive to accelerate depreciation on buildings.

Most real estate investors use straight-line depreciation anyway, so this distinction is largely academic. The 25% rate is the relevant rule for nearly all residential and commercial real estate.

Real estate sales and the blow-to-basis rule

The IRS calculates the unrecaptured gain by comparing your sales price to your adjusted basis. Your adjusted basis is your original cost less all depreciation deductions you’ve claimed (or should have claimed). Even if you forgot to claim depreciation in some years, the IRS may impute it, increasing your recapture obligation.

This is why real estate investors must track depreciation carefully. Failing to claim it reduces your current taxable income but increases your recapture tax bill later.

Mix-use properties and partial depreciation

If you own a property with both residential and commercial use, depreciation (and thus recapture) applies only to the commercial or rental portion. Your primary residence, which is not depreciated, generates no Section 1250 recapture. This is one reason the exclusion on primary residence gains ($250,000 for individuals, $500,000 for married couples) can be so valuable—you avoid capital gains tax entirely on appreciation, with no recapture component.

State and local taxes

The 25% rate applies to federal tax only. Many states also recapture depreciation, sometimes at ordinary income rates. Your effective recapture rate can be substantially higher when you include state tax, especially in high-income states like California or New York.

Planning and deferral strategies

Because Section 1250 recapture is inevitable, some investors use 1031 exchanges to defer the sale. By exchanging your property for a like-kind property (another piece of real estate) rather than selling outright, you defer the capital gain—and the recapture—indefinitely. However, you carry forward your old basis, so recapture will eventually be due if you ever exit the exchange chain.

Other investors accept the 25% rate as a cost of doing business and factor it into their expected returns when deciding whether to hold, sell, or exchange a property.

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