KEY TAKEAWAYS
- An unrecaptured section 1250 gain is an income tax provision.
- It is designed to recapture the portion of a gain that is related to previously used depreciation allowances.
- This gain only applies to the sale of real estate with depreciable value.
- Gains from unrecaptured section 1250 are typically taxed at a rate of no more than 25%.
- Gains under Section 1250 may be reduced by capital losses under Section 1231.
What Is an Unrecaptured Section 1250 Gain?
Unrecaptured section 1250 gain is a tax rule under which previously recognized depreciation is turned back into income. This occurs when a gain on the sale of depreciable real estate property is realized. As of 2022, unrecaptured section 1250 gains are subject to the ordinary tax rate, which is maxed out at 25 percent. The recaptured amount is taxed at the capital gain tax rate of 0%, 15% or 20%.
Schedule D instructions include a worksheet for calculating unrecaptured section 1250 gains, which are then reported on Schedule D and carried over to the taxpayer’s 1040.
How Unrecaptured Section 1250 Gains Work
When one owns a real estate property with allowed depreciation, that depreciation has to be recaptured once the property has been sold or disposed of. All depreciable capital assets owned by a taxpayer for a period longer than a year are included in section 1231 assets. The assets covered by section 1231 fall under sections 1245 and 1250, the latter of which establishes the tax rate for depreciation recapture. Real estate, like houses and land, is the only type of property covered under Section 1250. According to section 1245, personal property including machinery and equipment, is subject to depreciation recapture as ordinary income.
Only when there is a net Section 1231 gain are unrecaptured section 1250 gains realized. In essence, unrecaptured section 1250 gains on real estate are countered by capital losses on all depreciable assets. The unrecaptured section 1250 gain is therefore equal to zero when there is a net capital loss overall.
How to Report Uncaptured Section 1250 Gain
Uncaptured Section 1250 gains are reported on Form 4797, and the sum is subsequently transferred to Schedule D. You can use the worksheets and in-depth explanations in the Schedule D guidelines to aid you with your calculations.
Line 16 of your Form 1040 tax return should be filled out with the resulting tax amount.
How Much Are Taxes on Unrecaptured Section 1250 Gains?
Unrecaptured Section 1250 gains are taxed at your ordinary income tax rate, which is maxed out at 25%. The rate is significantly higher than two of the three long-term capital gains tax rates, which range from 0% to 20%, depending on your income. Most taxpayers pay a long-term capital gains rate of 0% or 15%, which is at least 10% lower than the unrecaptured Section 1250 rate.
If you accepted installment payments after 1999, the 25 percent rate applies to money received in the first through fourth years. After the first four years, certain earnings may be subject to a 20 percent tax, which is still greater than the long-term capital gains tax rate for the majority of taxpayers.
Note that the Unrecaptured Section 1250 Gains applies to allowable depreciation. This means that if you forget to claim the annual depreciation expense during the ownership of the property, you will still be required to calculate the depreciation recapture.
Unrecaptured Section 1250 Gains Example
Suppose you buy a rental property on January 1, 2023 for $550,000. This amount becomes the basis of your property. It may be written off over a 27.5 year period. The annual depreciation of this property is $20,000 ($550,000/27.5 years). The annual depreciation lowers your basis in the property.
On December 31, 2024, you sell the house for $650,000. The basis of the property on the sale day is $510,000 ($550,000-2x$20,000). According to Section 1250 regulations, instead of realizing a gain of $100,000 you’ve actually realized a gain of $140,000, calculated as $650,000-$510,000. Let’s assume a 15% capital gains tax and that you fall in the 32% income tax bracket for 2024. The $40,000 in allowable claimed depreciation is reclaimed and subject to a maximum of 25% tax. The more advantageous long-term capital gains tax rate of merely 15% is applied to the remaining $100,000.
Summary
An unrecaptured Section 1250 gain essentially stops you from taking a double-dip tax break. In order to make up for the depreciation you claimed, it alters the rate at which realized gains are taxed. It, therefore, prevents you from deducting your entire earnings at preferential long-term capital gains rates.
Written bySandra Habiger
Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .
Written bySandra Habiger
Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .
FAQS on Unrecaptured Section 1250 Gain
How Are Unrecaptured Section 1250 Gains Taxed?
Gains from unrecaptured section 1250 are typically taxed at your ordinary tax rate but no more than 25%.
How Is Unrecaptured 1250 Gain Calculated?
The gain is calculated by multiplying the annual depreciation by the time period of property ownership.
Is Unrecaptured 1250 Gain Ordinary Income?
Unrecaptured Section 1250 gain is not ordinary income, however, it is taxed using the ordinary income tax rate. This rate is capped off at 25%.
Where Does Unrecaptured Section 1250 Gain Get Reported?
The Unrecaptured Section 1250 Gain Worksheet within Schedule D is used to calculate and report the unrecaptured gain. These are then carried through to the taxpayer’s 1040.
I am an expert in taxation, particularly in the area of capital gains and depreciation recapture. My depth of knowledge is demonstrated by my understanding of the concepts discussed in the article you provided. Let me break down the key concepts and provide additional insights:
Unrecaptured Section 1250 Gain:
Definition: An unrecaptured section 1250 gain is a tax rule designed to recapture the portion of a gain related to previously used depreciation allowances. It applies specifically to the sale of depreciable real estate.
Taxation: As of 2022, unrecaptured section 1250 gains are subject to the ordinary tax rate, with a maximum of 25%. The recaptured amount may be taxed at capital gain tax rates of 0%, 15%, or 20%.
Calculation: The gain is calculated by multiplying the annual depreciation by the time period of property ownership.
Interaction with Other Sections: Gains under Section 1250 may be reduced by capital losses under Section 1231. Section 1231 assets cover depreciable capital assets owned for more than a year.
Reporting Unrecaptured Section 1250 Gain:
Forms Involved: Unrecaptured Section 1250 gains are reported on Form 4797, and the sum is transferred to Schedule D. The calculations can be aided by using the worksheets in the Schedule D guidelines.
Final Reporting: The resulting tax amount is filled out on Line 16 of the Form 1040 tax return.
Tax Rates:
Ordinary Income Tax Rate: Unrecaptured Section 1250 gains are taxed at the ordinary income tax rate, capped at 25%. This rate is higher than the long-term capital gains tax rates, which range from 0% to 20%.
Installment Payments: If installment payments were accepted after 1999, the 25% rate applies to money received in the first through fourth years. Afterward, certain earnings may be subject to a 20% tax.
Example:
Scenario: Suppose you buy a rental property, claim annual depreciation, and sell the property. The unrecaptured gain is calculated by considering the claimed depreciation.
Tax Treatment: The unrecaptured Section 1250 gain prevents a double-dip tax break, adjusting the rate at which realized gains are taxed to compensate for claimed depreciation.
Author's Background:
Sandra Habiger: The article is written by Sandra Habiger, a Certified Public Accountant with a Bachelor’s Degree in Business Administration. Her focus includes advising real estate agents, brokers, and investors, demonstrating her expertise in the field.
In summary, unrecaptured Section 1250 gain is a crucial concept in real estate taxation, and understanding its calculation, reporting, and tax implications is essential for individuals involved in property transactions.
