Footnotes · EA Part 2 study notes · Depreciation · Depreciation Recapture

Depreciation Recapture

At the desk

Form	4797: Part III for 1245/1250 recapture, Part I for net 1231, Part II ordinary
Property types	See the table just below: 1231 vs 1245 vs 1250 vs capital asset
1245 (equipment, vehicles, intangibles)	Gain is ordinary up to all depreciation taken (incl. 179 and bonus); excess is 1231
1250 (buildings)	Straight-line depreciation is not recaptured as ordinary, but is 'unrecaptured 1250 gain' taxed at up to 25%; the rest is 1231
1231 netting	Net gain → long-term capital; net loss → ordinary. 5-year lookback turns current gain ordinary to the extent of prior net 1231 losses
2026 LTCG thresholds	0% to $49,450 single / $98,900 MFJ · 15% to $545,500 / $613,700 · 20% above
Trap	Vehicle trade-ins are taxable sales since 2018 — recapture on the trade-in allowance. Cost-seg and QIP bonus create 1245 recapture on a building sale

Sections 1231, 1245, and 1250 recharacterize gain or loss. None of these rules changed under the 2025 tax act; only the capital gain rate thresholds move each year.

Note. Remember that while these Sections may change the character of gain or loss, they will not change the amount of any gain or loss.

Property Types at a Glance

Which section applies added 2026
Section	What it is	Typical examples	Held	Gain on sale	Loss on sale	Form 4797
1231	Real or depreciable property used in a trade or business, plus involuntarily converted business or investment capital assets	Land, buildings, equipment, vehicles, livestock held for breeding or dairy, timber, unharvested crops	More than 1 year	Net 1231 gain is long-term capital (after 1245/1250 recapture and the 5-year lookback)	Net 1231 loss is ordinary	Part I
1245	Depreciable personal property, tangible or intangible; also a few kinds of real property such as single-purpose agricultural structures and petroleum storage	Machinery, computers, furniture, cars and trucks, patents, acquired goodwill and other Sec. 197 intangibles, leaseholds of 1245 property	Any (recapture applies even if held 1 year or less)	Ordinary to the extent of all depreciation, amortization, Sec. 179 and bonus taken; any excess is 1231 gain	Not 1245 — a loss is 1231 (over 1 year) or ordinary (1 year or less)	Part III
1250	Depreciable real property that is not 1245 property	Office and apartment buildings, warehouses, rental houses, structural components, leases of land	Any	Accelerated depreciation in excess of straight-line is ordinary (rare since 1987); for individuals the straight-line part is "unrecaptured 1250 gain" at up to 25%; the rest is 1231 gain. Corporations add 20% of the would-be 1245 amount as ordinary (Sec. 291)	A loss is 1231	Part III
Capital asset	Everything that is not inventory, not business property, not business receivables, and not a creative work of its maker	Stocks, personal residence, personal car, investment land	Over 1 year = long-term	Capital gain	Capital loss (personal-use losses not deductible)	Schedule D, not 4797
Ordinary (not 1231)	Inventory, property held for sale to customers, business property held 1 year or less, accounts receivable	Dealer's lots, a contractor's spec house, equipment sold within a year	1 year or less	Ordinary	Ordinary	Part II

Land is pure 1231 property: never 1245 or 1250 because it is not depreciable.
A building and its land are separate assets on sale: allocate the price, then the land goes to 1231 and the building to 1250.
Order of operations on a sale of business property: (1) 1245 or 1250 recapture to ordinary, (2) 1231 lookback to ordinary, (3) net the rest of the 1231 gains and losses, (4) net gain goes to Schedule D as long-term (25% portion first), net loss is ordinary.

Section 1231 Property

Section 1231 business assets are truly "the best of both worlds" because they treat losses as ordinary losses (able to offset ordinary income) and tax gains at the preferable capital gains tax rate.

Section 1231 property is property held for more than 1 year.
- It includes:
  - All real or depreciable property used in a trade or business
  - Involuntarily converted capital assets held in connection with a trade or business or in a transaction entered into for a profit
- Examples of Sec. 1231 property include land, apartment buildings, parking lots, manufacturing equipment, and involuntarily converted investment artwork.
- Land is not depreciable. Thus, it does not fall within Sec. 1245 or Sec. 1250. Land is referred to as pure Sec. 1231 property if used for trade or business and held for more than 1 year.
- Examples that are not Sec. 1231 property include personal-use property and inventory.
- Section 1231 is beneficial to the taxpayer. When Sec. 1231 property gains exceed losses (a net Sec. 1231 gain), each gain or loss is treated as being from the sale of a long-term capital asset. However, if Sec. 1231 property losses exceed gains (a net Sec. 1231 loss), each gain or loss is considered ordinary. Section 1231 has a two-step test.
  - Step 1: Determine net gain or loss from all casualties or thefts of Sec. 1231 property for the tax year. Gain or loss from involuntary conversions by other than casualty or theft is included in Step 2 but not Step 1.
    - If the result is a net loss, each gain or loss is treated as ordinary income or loss.
    - If the result is a net gain, each gain or loss is included in Step 2.
  - Step 2: Determine net gain or loss from all dispositions of Sec. 1231 property for the year, including the property included in Step 1 only if Step 1 resulted in a net gain.
    - If the result is a net loss, each gain or loss is treated as ordinary income or loss.
    - If the result is a net gain, each gain or loss is treated as a long-term capital gain or loss.

Example — Section 1231 Loss on Sale

A business taxpayer sold for scrap outdated equipment purchased years ago. The equipment had an adjusted basis of $5,000 and a sale price of $2,000. Business equipment held longer than a year is Sec. 1231 property, and, when sold at a loss, the loss is ordinary, not capital. If this business had $10,000 taxable income from operations and no other transactions, its taxable income for the year would be $7,000 ($10,000 taxable income – $3,000 loss).

Example — Net Section 1231 Gain/Loss, Capital/Ordinary

A taxpayer holding two lots of land used for business sells Lot 1 for a $50,000 long-term gain and Lot 2 for a $60,000 long-term loss. Because land used for business is Sec. 1231 property, the net $10,000 loss ($50,000 gain – $60,000 loss) is an ordinary loss, not a capital loss. If, however, Lot 1 was a $60,000 long-term gain and Lot 2 a $50,000 long-term loss, then the net $10,000 gain ($60,000 gain – $50,000 loss) would be a capital, not ordinary, gain.

Recapture (the lookback rule). Net gain on Sec. 1231 property is treated as ordinary income (OI) to the extent of unrecaptured net Sec. 1231 losses from preceding tax years.
- Unrecaptured net Sec. 1231 losses are the total of net Sec. 1231 losses for the last 5 tax years, reduced by net Sec. 1231 gains characterized as ordinary income under Sec. 1231(c).
- Sections 1245 and 1250 recapture is computed before Sec. 1231 recapture, but Sec. 1231 recapture is computed before Steps 1 and 2 above.
  Note. The use of the term "recapture" in reference to recapturing current-year gain as ordinary income to the extent of prior-year loss under Sec. 1231 is not to be confused with the recapture of depreciation as ordinary income under Secs. 1245 and 1250.
The installment method can apply to Sec. 1231 property. Section 1231 merely characterizes gain or loss. Any Sec. 1231 gain that is recharacterized as capital gain will first consist of 25% gain, then 0/15/20% gain.
Allocation is required when Sec. 1245 or Sec. 1250 property is also Sec. 1231 property and only a portion of gain recognized is Sec. 1245 or Sec. 1250 OI.
Sections 1245 and 1250 only involve gains. If disposition of business property results in a loss, the loss is a Sec. 1231 loss.

Example — Section 1231 Recapture (Lookback Rule)

A taxpayer has a $5,000 net Sec. 1231 loss in Year 1, gains in Years 2, 4, 5, and 6 totaling $4,500, a $3,000 net Sec. 1231 loss in Year 3, and a $4,000 gain in Year 7. The gains in Years 2, 4, 5, and 6 ($4,500) are recaptured as ordinary income by the Year 1 loss. The remaining $500 of the Year 1 loss is more than 5 years old by Year 7 and is not applied. In Year 7, $3,000 of the $4,000 gain is recaptured as ordinary income by the Year 3 loss. The remaining $1,000 is Sec. 1231 gain. Thus, the Year 7 gain is a net long-term capital gain of $1,000 and ordinary income of $3,000.

Section 1245 Ordinary Income

Section 1245 property generally is depreciable personal property (tangible or intangible) used in a trade or business for over 12 months. Think of it as "ordinary" getting "recaptured."

Gain recognized on the disposition of Sec. 1245 property is OI to the extent of the lesser of all depreciation taken (including amounts expensed under Sec. 179 and bonus depreciation) or gain realized.
- If gain realized is not recognized (like-kind exchanges, involuntary conversions, etc.), Sec. 1245 OI is limited to the sum of the following:
  - Gain recognized
  - FMV of property acquired that is not Sec. 1245 property and is not included in computing the recognized gain
- The recognized gain in excess of the depreciation taken may be treated as a gain from the sale or exchange of Sec. 1231 property.
- added 2026 Since 2018, like-kind exchanges are limited to real property. A trade-in of equipment or a vehicle is now a taxable sale, so Sec. 1245 recapture applies to the trade-in allowance.

Example — Section 1245 Ordinary Income

Stewart purchased a machine for $20,000. He took $14,000 in depreciation before selling the asset for $9,000. The basis on the machine is $6,000 ($20,000 cost basis – $14,000 depreciation), so he has a $3,000 gain ($9,000 selling price – $6,000 basis). The $3,000 is ordinary income (the lesser of the gain or depreciation taken).

Example — Section 1245 Ordinary Income and Section 1231 Gain

Assume the same facts except Stewart sells the machine for $25,000. The realized gain is $19,000 ($25,000 – $6,000 basis). This gain has both Sec. 1245 gain (ordinary income) and Sec. 1231 gain (long-term capital). The $14,000 of depreciation taken on the equipment is a Sec. 1245 gain (the lesser of the gain or depreciation taken), and the remaining gain of $5,000 is a Sec. 1231 gain.

Example — Section 1245 and 1231 Recapture

A business with a Sec. 1231 loss of $3,000 in Year 1 sells equipment in Year 2 for an $11,000 realized gain, of which $6,000 is depreciation taken. $9,000 ($6,000 Sec. 1245 depreciation recapture + $3,000 Year 1 Sec. 1231 loss recapture) is ordinary income. The remaining $2,000 ($11,000 realized – $9,000 ordinary income) is Sec. 1231 capital gain.

Examples of intangible amortizable personal Sec. 1245 property include
- Leaseholds of Sec. 1245 property
- Professional athletic contracts, e.g., baseball
- Patents
- Goodwill acquired in connection with the acquisition of a trade or business
- Covenants not to compete

Example — Intangible Section 1245 Property

The sale of a taxpayer's business includes goodwill with a tax basis of $15,000. The goodwill was acquired three years ago and amortized $1,000 per year. The goodwill was allocated $22,000 of the sale price; therefore, the $3,000 of total amortization ($1,000 × 3 years) is ordinary income to the taxpayer. The remaining $10,000 of gain ($22,000 – $12,000 adjusted basis) is Sec. 1231 gain.

Section 1250 Ordinary Income

Section 1250 property is all depreciable real property, such as a building or its structural components.
- Examples of Sec. 1250 property include shopping malls, an apartment or office building, low-income housing, rented portions of residences, and escalators or elevators.
- Land is not Sec. 1250 property, but leases of land are Sec. 1250 intangible properties. Certain improvements to land may be treated as land, e.g., dams and irrigation systems.
- Sec. 1250 property is subject to its own recapture rules.
  - The excess of accelerated depreciation taken over S-L depreciation is OI to the extent of gain recognized. This applies to purchases made before 1987.
    - However, because most Sec. 1250 property (e.g., 39-year nonresidential real property and 27.5-year residential real property) has been depreciated using straight-line since 1987, it is relatively uncommon to encounter Sec. 1250 recapture.
    - added 2026 Watch for it anyway: bonus depreciation on qualified improvement property, and a cost-segregation study that reclassifies building components as 5-, 7-, or 15-year property, both create "additional depreciation" that is recaptured as ordinary income under Sec. 1245 or Sec. 1250 on sale.
  - For property held less than 1 year, any depreciation taken is recaptured as OI.
  - For corporations, the gain must be computed under both Sec. 1245 and 1250. If Sec. 1245 gain is larger than Sec. 1250 gain, 20% of the difference is characterized as ordinary income (Sec. 291).
- If gain realized is not recognized (like-kind exchanges, involuntary conversions, etc.), Sec. 1250 OI is limited to the greater of the following:
  - Recognized gain
  - Excess of the potential Sec. 1250 OI over the FMV of Sec. 1250 property received

Section 1250 Unrecaptured Gain

For corporate and noncorporate taxpayers, any gain from the disposition of Sec. 1250 property that is not recaptured as ordinary income will qualify as Sec. 1231 gain.
- For individual taxpayers, any portion of that gain that is attributable to straight-line depreciation will be subject to a maximum capital gains rate of 25% (as opposed to 0/15/20%).
- added 2026 The 25% is a ceiling. A taxpayer whose ordinary income already fills the 10% or 12% bracket pays tax on unrecaptured 1250 gain at the ordinary rate that applies, up to 25%.

Long-Term Capital Gain Rate Thresholds for 2026 (taxable income) added 2026
Filing status	0% up to	15% up to	20% above
Single	$49,450	$545,500	$545,500
Married filing jointly	$98,900	$613,700	$613,700
Head of household	$66,200	$579,600	$579,600
Married filing separately	$49,450	$306,850	$306,850
Estates and trusts	$3,300	$16,250	$16,250

Example — Section 1250 Unrecaptured Gain Taxed as Section 1231 Gain

Annie sold a building used in her trade or business for $110,000. Annie purchased the building several years ago for $100,000. At the time of the sale, the building has accumulated depreciation of $20,000. The building was depreciated using the straight-line method; Sec. 1250 recapture does not apply, and Annie has a Sec. 1231 gain of $30,000 ($110,000 amount realized – $80,000 adjusted basis). Of the $30,000 gain, $20,000 is attributable to straight-line depreciation and is classified as Sec. 1250 unrecaptured gain, which is subject to a maximum rate of 25%. The remaining $10,000 gain is taxed at a maximum rate of 0/15/20%.

Section 351 Exchange for Stock

Generally, no gain is recognized upon an exchange of property for all the stock of a newly formed corporation.
- Section 1245 and Sec. 1250 OI is limited to any gain recognized in a Sec. 351 transaction.

Example — Section 1245 Recapture

On January 17, Year 1, Relief Corp. purchased and placed into service 7-year MACRS tangible property costing $100,000. On December 21, Year 4, Relief Corp. sold the property for $105,000 after taking $60,000 in MACRS depreciation deductions. The adjusted basis of the property is $40,000 ($100,000 historical cost – $60,000 depreciation); therefore, Relief will recognize a gain of $65,000 ($105,000 selling price – $40,000 adjusted basis). Since this property qualifies for Sec. 1245 recapture, the gain is recaptured as ordinary income to the extent of the lesser of all depreciation taken or gain recognized. Thus, Relief will have $60,000 of Sec. 1245 (ordinary) gain. The remaining $5,000 of gain is Sec. 1231 (capital) gain.

Example — Section 1250 Unrecapture

Martha purchased and placed into service Sec. 1250 property costing $600,000. After 5 years, the property was sold for $650,000 after having taken $300,000 in straight-line depreciation deductions. The adjusted basis of the property is $300,000 ($600,000 historical cost – $300,000 depreciation); therefore, Martha recognizes a gain of $350,000 ($650,000 selling price – $300,000 adjusted basis). Because the property was depreciated using straight-line depreciation, Sec. 1250 recapture will not apply. Thus, Martha will have $350,000 of Sec. 1231 (capital) gain, $300,000 of which is Sec. 1250 unrecaptured gain taxed at a maximum rate of 25%.

Private reference, not client advice. Original notes written 2022–2023 while studying for the SEE Part 2; figures updated October 2026 (Rev. Proc. 2025-32, Rev. Proc. 2026-15, P.L. 119-21). Verify current-year amounts before relying on them.