When you sell a rental property or business asset, you may owe more in taxes than expected. Years of claiming depreciation deductions lowered your taxable income each year, but the IRS collects a portion of that benefit back at sale. This is depreciation recapture, and it frequently surprises sellers who plan only around capital gains rates.
What Is Depreciation Recapture?
When you own a business asset or rental property, the tax code lets you deduct its cost over time through depreciation. Those deductions reduce your taxable income each year and lower your adjusted basis in the asset.
When you sell, the IRS compares the sale price to your adjusted basis (original cost minus total depreciation claimed). Any gain up to the amount of depreciation you deducted is "recaptured" and taxed at higher rates than ordinary long-term capital gains.
Section 1245 vs. Section 1250: The Two Types of Recapture
The type of property determines how recapture is taxed.
Section 1245 Property
CautionCovers personal property used in a business: equipment, machinery, vehicles, computers, furniture, and fixtures. All depreciation previously claimed is recaptured at ordinary income rates, up to 37% in 2026. The recaptured amount can never exceed the total depreciation deducted. Reported on Form 4797, Part III.
Under the OBBBA (signed July 4, 2025), Section 168(n) qualified production property (newly constructed U.S. manufacturing facilities) is now also treated as Section 1245 property. Selling these assets before a 5-year recovery period may trigger full ordinary income recapture.
Section 1250 Real Property
Covers commercial buildings, residential rental properties, and structural components. The IRS applies a narrower concept: unrecaptured Section 1250 gain, equal to straight-line depreciation previously claimed on real property. This portion of the gain is taxed at a maximum 25% rate (not the 37% ordinary rate), but still above the 0-20% long-term capital gains brackets. Reported on Form 4797, Part III and carried to Schedule D.
How Form 4797 Calculates the Tax
Form 4797 (Sales of Business Property) handles all asset dispositions. Part III calculates the ordinary income recapture portion. Any remaining gain above total depreciation claimed flows to Schedule D as long-term capital gain taxed at preferential rates.
Example: You sell a rental building for $500,000. Your original cost was $400,000, and you claimed $80,000 in straight-line depreciation over 10 years. Your adjusted basis is $320,000. The $180,000 total gain splits as follows:
- $80,000 unrecaptured Section 1250 gain (taxed at max 25%)
- $100,000 remaining gain (taxed at long-term capital gains rates: 0%, 15%, or 20%)
Can You Defer Depreciation Recapture?
Section 1031 like-kind exchange: You can defer recapture by exchanging into a qualifying replacement property. The deferred recapture carries into the replacement property's basis. It is postponed, not eliminated.
Installment sale (Form 6252): Spreading proceeds over multiple years spreads the tax across those years, though the recapture rate does not change.
Holding until death: Heirs receive a stepped-up basis under IRC Section 1014, eliminating all embedded gain including accumulated recapture. For long-held real estate, this is often the most powerful planning tool.
Planning Before You Sell
Recapture calculations should happen before you list, not after closing. The tax on recapture is due in the year of sale regardless of whether you reinvest the proceeds. A CPA can run a pre-sale analysis to model different exit structures and minimize what you owe.
Contact TS CPA before selling any business property or rental asset. We respond within the same day.