A frequent question we receive is the tax treatment of recaptured depreciation from the sale of real estate rental property. Gain from selling Sec 1250 property (real estate) is subject to recapture – the excess of the actual amount of depreciation previously claimed for the property over the amount of depreciation that would have been allowable under the straight-line method, limited to the gain on the sale, is taxed as ordinary income. However, this means that as long as the property is being depreciated using a straight-line method and held over a year, there is no Sec 1250 recapture but there will be “unrecaptured Sec 1250 gain,” which is taxed at a maximum rate of 25%. The balance of the gain, if any, is taxed at the normal capital gains rate based upon the individual’s regular tax rate, as follows:
- The LTCG tax rate is zero to the extent the taxpayer’s taxable income bracket is below 25%.
- The LTCG tax rate is 15% to the extent the taxpayer’s taxable income bracket is above 25% and below 39.6%
- The LTCG tax rate is 20% to the extent the taxpayer’s taxable income bracket is 39.6%
Rental real estate depreciation rates have been mandatorily straight line since 1987 with residential rentals being depreciated over 27.5 years and commercial property depreciated over 31.5 years or 39 years if placed in service after 5/12/1993. Thus in nearly all cases it is impossible for real estate property sold in 2017 to have been depreciated at other than straight-line, and therefore no amount of depreciation is recaptured as Sec 1250 gain (Code Sec. 168(b)(3)(A)). But the amount of depreciation claimed on Sec 1250 property that is not recaptured as ordinary income under the Sec1250 recapture rules is unrecaptured section 1250 gain, and is subject to a special capital gain tax rate of 25%.
Example: Jack, an individual, sells nonresidential real property on Aug. 15 for $200,000, realizing a gain of $50,000. This is Jack's only transaction involving a capital asset for the year. Jack held the property for more than one year. He depreciated the property using MACRS (straight-line), and claimed $25,000 of depreciation during his ownership. There is no depreciation recapture under Sec 1250 because Jack didn't claim accelerated depreciation. However, $25,000 of Jack's gain, representing depreciation deductions he had claimed, is unrecaptured Sec. 1250 gain. Lines 26a and 26g of Jack’s Form 4797 will be zeroes because straight-line depreciation was used. The Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions will need to be completed before Jack’s Schedule D Tax Worksheet can be computed. The maximum amount of tax he’ll pay on the $25,000 of unrecaptured Sec 1250 gain is $6,250 (25% x $25,000) but his tax on the unrecaptured 1250 gain could be much less depending on his other income and the tax bracket he falls into.
Special Recapture Situations
Even if straight-line depreciation is used to claim the regular depreciation deduction, depreciation recapture will apply in the following situations:
- Bonus Depreciation – If bonus depreciation is claimed on qualified leasehold improvement property placed in service before 2016 or qualified improvement property placed in service after 2015, the Sec 1250 recapture rules apply. The recapture amount is equal to the difference between the bonus deduction claimed and straight-line depreciation that could have been claimed on the bonus deduction.
- Sec 179 - If a Sec 179 deduction is claimed on Sec 1250 property (e.g., qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property), the Sec 179 allowance is subject to recapture under the recapture rules of Sec 1245. In this case, to the extent the gain is allocable to the expensed portion of the property, the Sec 179 amount may be recaptured in full as ordinary income.
FAQs
Section 1250 recapture is the gain to the extent of the excess of depreciation claimed over straight-line and is taxed at ordinary income rates. Unrecaptured 1250 gain is the gain to the extent of straight-line depreciation taken and is taxed at a 25% maximum rate.
Do you pay both capital gains and depreciation recapture? ›
Depreciation expense taken by a real estate investor is recaptured when the property is sold. Depreciation recapture is taxed at an investor's ordinary income tax rate, up to a maximum of 25%. Remaining profits from the sale of a rental property are taxed at the capital gains tax rate of 0%, 15%, or 20%.
How do I record unrecaptured Section 1250 gain? ›
Unrecaptured 1250 gain is calculated by subtracting Line 26g on Form 4797 from the smaller of line 22 or 24. Lacerte calculates this automatically and carries it to Form 1065, Schedule K, line 9c.
How to avoid depreciation recapture tax on rental property? ›
If it's important to you to avoid the depreciation recapture tax, there are several strategies you may want to adopt.
- Take advantage of IRS Section 121 exclusion. ...
- Conduct a 1031 exchange. ...
- Pass on the property to your heirs. ...
- Sell the property at a loss.
How Do I Calculate Section 1250 Recapture? Section 1250 is calculated as the lesser of two amounts. The first amount is the excess of accelerated depreciation claimed on real property over what would have been the allowable amount under a straight-line method. The second amount is the gain realized upon disposition.
What is the 1250 recapture rule? ›
Section 1250 depreciation, which is deducted over 39 years using the straight-line method, will generate accumulated depreciation over the years. This accumulated 1250 depreciation is taxed at a flat rate of 25% upon disposition (sale), up to a maximum of the amount of the recognized gain.
How is depreciation recapture taxed on rental property? ›
Depreciation recapture is treated as ordinary income and taxed as such. With real estate, it's a little more complicated. The gain beyond the original cost basis is taxed as a capital gain, whereas the part that is related to depreciation is taxed at the unrecaptured gains section 1250 tax rate, which is capped at 25%.
Why does 1250 recapture no longer apply? ›
Depreciable real property is often, but not always, depreciated utilizing the straight-line method. In these situations, Sec. 1250 would not be applicable since there would be no additional depreciation to recapture, but the unrecaptured Sec. 1250 gain rules may apply.
Is depreciation recapture always taxed at 25%? ›
Depreciation Recapture Tax is one of the highest tax rates associated with the sale of real estate, a depreciable asset. Depreciation Recapture tax is 25% across the board, only second to real estate owned less than one year, taxed as ordinary income which could be as high as 37%.
Do I need to report unrecaptured Section 1250 gain? ›
For details on unrecaptured section 1250 gain, see the instructions for line 19. Generally, gain from the sale or ex- change of a capital asset held for person- al use is a capital gain. Report it on Form 8949 with box C checked (if the transaction is short term) or box F checked (if the transaction is long term).
The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.
Is unrecaptured 1250 gain taxed at ordinary rates? ›
Any gain in excess of the amount treated as ordinary income because of Section 1250 recapture, but not exceeding the total depreciation claimed, is "unrecaptured Section 1250 gain". Unrecaptured Section 1250 gain will be taxed at a maximum rate of 25%.
What is the loophole of depreciation recapture? ›
The process of depreciation recapture closes a tax loophole that allowed taxpayers to take depreciation deductions against ordinary income while the subsequent sale of those assets was taxed at lower capital gain rates.
Do I have to recapture all depreciation on a rental property? ›
This tax is the rental property depreciation recapture. The IRS taxes the capital gain attributed to the depreciation deductions taken during ownership. Depreciation can initially reduce taxable income on capital assets, but upon sale, a portion of these deductions must be repaid through depreciation recapture.
Do you have to recapture depreciation on sale of rental property? ›
When selling rental property, clients will face a capital gains tax (the rate depends on their taxable income and filing status), and a depreciation recapture tax rate that is capped at 25%. Clients with a higher income may also be subject to net investment income tax (NIIT).
Why does 1250 recapture generally no longer apply? ›
Depreciable real property is often, but not always, depreciated utilizing the straight-line method. In these situations, Sec. 1250 would not be applicable since there would be no additional depreciation to recapture, but the unrecaptured Sec. 1250 gain rules may apply.
Are unrecaptured 1250 gains apply only to individuals True or false? ›
False. Unrecaptured §1250 gains apply to both individuals and corporations.
Is depreciation recapture always taxed at 25? ›
Depreciation recapture is treated as ordinary income and taxed as such. With real estate, it's a little more complicated. The gain beyond the original cost basis is taxed as a capital gain, whereas the part that is related to depreciation is taxed at the unrecaptured gains section 1250 tax rate, which is capped at 25%.
A frequent question we receive is the tax treatment of recaptured depreciation from the sale of real estate rental property. Gain from selling Sec 1250 property (real estate) is subject to recapture – the excess of the actual amount of depreciation previously claimed for the property over the amount of depreciation that would have been allowable under the straight-line method, limited to the gain on the sale, is taxed as ordinary income. However, this means that as long as the property is being depreciated using a straight-line method and held over a year, there is no Sec 1250 recapture but there will be “unrecaptured Sec 1250 gain,” which is taxed at a maximum rate of 25%. The balance of the gain, if any, is taxed at the normal capital gains rate based upon the individual’s regular tax rate, as follows: