When you sell a fully depreciated asset used in your business, nearly the entire sale price is taxable gain, and most of it is taxed as ordinary income through depreciation recapture rather than at the lower long-term capital gains rates. Because years of depreciation deductions have already reduced your adjusted basis to zero, there is no cost left to offset what the buyer pays you. How much of that gain lands in the ordinary-income bucket, how much qualifies for capital gains treatment, and whether any of it can be deferred depend on the type of asset, who buys it, and how the deal is structured.
Why the Entire Sale Price Is Gain
Adjusted basis starts with what you paid and drops by every depreciation deduction you claimed.1Internal Revenue Service. Publication 946 (2025), How To Depreciate Property Full depreciation drives that basis to zero, so the sale price minus selling costs is your realized gain.
A quick example. You paid $80,000 for a piece of equipment, claimed $80,000 in total depreciation over the years, and sell it for $25,000. Basis is zero. Realized gain is $25,000. That is your starting number. What matters next is how the tax code carves that gain into pieces.
Equipment, Vehicles, and Other Personal Property
Tangible personal property used in a business, including machinery, vehicles, computers, and office furniture, falls under Section 1245. Any gain up to the total depreciation you previously claimed is recaptured and taxed at your ordinary income rate.2Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property For a fully depreciated asset, recapture almost always eats the entire gain, because the depreciation total will meet or exceed what the sale produces.
Back to the $80,000 equipment. Sold for $25,000, all $25,000 is ordinary income at your marginal rate, which for 2026 can reach 37%.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 No capital gains treatment applies, because recapture swallows the gain whole.
Change one number and the picture shifts. Sell that same equipment for $95,000 and your gain is $95,000. The first $80,000, matching total depreciation, is ordinary income under Section 1245. The remaining $15,000, the excess over original cost, moves into Section 1231 territory covered below.
The depreciation method you used does not change this. Bonus depreciation, MACRS, and Section 179 expensing all count as depreciation for recapture purposes. Writing off $200,000 of equipment with Section 179 in year one and selling three years later for $50,000 produces $50,000 of ordinary income. Accelerating the deduction did not accelerate any tax benefit past the sale.
Buildings and Other Real Property
Real property lives under Section 1250 instead.4Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty Section 1250 only recaptures depreciation as ordinary income to the extent you claimed more than straight-line. Because real property placed in service after 1986 must use straight-line, ordinary income recapture on modern buildings is typically zero.
The depreciation is not tax-free, though. The portion of gain attributable to straight-line depreciation is called unrecaptured Section 1250 gain and is taxed at a maximum rate of 25%.5Internal Revenue Service. TD 8836 – Unrecaptured Section 1250 Gain That sits between ordinary rates and long-term capital gains rates.
A commercial building bought for $500,000 and depreciated to zero over 39 years using straight-line, then sold for $300,000, produces $300,000 of unrecaptured Section 1250 gain taxed at 25%. Sell it for $600,000 instead, and the first $500,000 (matching total depreciation) is unrecaptured Section 1250 gain at 25%, and the remaining $100,000 becomes Section 1231 gain.
Allocating Between Land and Building
Land is not depreciable, so when selling improved real estate you must split the price between land and building. Only the building portion triggers recapture. The IRS expects allocations to track fair market value; shifting sale price toward land to shrink recapture invites scrutiny, and an independent appraisal is the safest support.
The C Corporation Add-On
C corporations face a harsher rule. Under Section 291, a corporation must treat an additional 20% of its total straight-line depreciation as ordinary income on top of whatever Section 1250 already recaptures.6Office of the Law Revision Counsel. 26 USC 291 – Special Rules Relating to Corporate Preference Items For a fully depreciated building where Section 1250 recapture would otherwise be zero, 20% of all depreciation becomes ordinary income and the other 80% remains taxed at the 25% unrecaptured Section 1250 rate.
When the Sale Price Exceeds Original Cost
Any gain above what you originally paid falls under Section 1231, which applies to depreciable business property and real property held more than one year.7Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions Section 1231 gives favorable treatment on both sides: net gains for the year qualify for long-term capital gains rates of 0%, 15%, or 20%, and net losses are deductible against ordinary income.
The netting happens after depreciation recapture has already been pulled out and taxed at ordinary rates. Only the leftover gain above original cost enters the Section 1231 bucket.
The Five-Year Lookback
Congress closed the obvious timing game. Any net Section 1231 gain in the current year is recharacterized as ordinary income to the extent of unrecaptured net Section 1231 losses from the prior five tax years.
If you reported a $20,000 net Section 1231 loss two years ago and deducted it against ordinary income, and this year you have a $35,000 net Section 1231 gain, the first $20,000 of that gain is reclassified as ordinary. Only $15,000 gets capital gains rates. Clean records over a rolling five-year window are essential.
The 3.8% Net Investment Income Tax
High-income taxpayers may owe an additional 3.8% surtax on gain from selling business property, depending on how actively they participated in the business. The tax applies when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers.8Internal Revenue Service. Net Investment Income Tax
Property held in a passive activity is exposed to the surtax; property from a business you actively run is not. The distinction matters most for rental real estate, where owners are generally passive unless they qualify as real estate professionals. With the surtax added, ordinary-income recapture can effectively reach 40.8% and unrecaptured Section 1250 gain can reach 28.8%.
Installment Sales Do Not Defer Recapture
Spreading payments across years does not spread the recapture tax. The IRS requires all recapture income to be recognized in the year of sale, even if no cash arrives that year.9Internal Revenue Service. Publication 537 (2025), Installment Sales Only gain above the recapture amount can be spread across the installment period.
Sell a fully depreciated piece of equipment for $60,000 with payments over three years, and the full $60,000 of Section 1245 recapture is taxable in year one. You report it on Form 4797, Part III, and carry it to line 12 of Form 6252. If the price had exceeded original cost, only the excess would qualify for installment treatment. This catches many sellers off guard.
Selling to a Related Party Makes It Worse
Selling a depreciable asset to a related party, whether your own corporation, a family member, or a partnership you control, triggers Section 1239. The entire gain is treated as ordinary income regardless of how it would otherwise be classified.10Office of the Law Revision Counsel. 26 U.S. Code 1239 – Gain From Sale of Depreciable Property Between Certain Related Taxpayers Any hope of Section 1231 capital gains treatment disappears. Related persons include entities in which you own more than 50% of the stock or partnership interest, along with certain trust arrangements.
Losses fare no better. Section 267 disallows a loss on a sale to a related party outright.11Office of the Law Revision Counsel. 26 U.S. Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers No deduction, and no basis pickup for the buyer.
Ways to Defer or Avoid the Tax
Section 1031 Exchanges (Real Property Only)
A like-kind exchange under Section 1031 lets you swap one piece of investment or business real property for another without recognizing gain at the time. The deferred gain, including the depreciation recapture piece, carries over to the replacement property. Since 2018, only real property qualifies; equipment, vehicles, and other personal property no longer do. A 1031 exchange into replacement real estate can defer the entire tax bill on a fully depreciated building indefinitely, though it comes due when the replacement is eventually sold in a taxable transaction.
Qualified Opportunity Funds
Capital gains, including Section 1231 gains from a fully depreciated asset, can be deferred by investing in a Qualified Opportunity Fund within 180 days of the sale. Deferred gain must be recognized by December 31, 2026, or when the QOF investment is sold, whichever comes first.12Internal Revenue Service. Opportunity Zones Frequently Asked Questions With the deferral deadline approaching, the remaining benefit for new investments is limited. Ordinary income from depreciation recapture cannot be deferred through a QOF.
Step-Up at Death
If a business owner dies still holding a fully depreciated asset, the heir takes a basis equal to fair market value on the date of death.13Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent All accumulated recapture disappears. An asset with a zero basis in the decedent’s hands might carry a $200,000 basis for the heir, who could sell immediately with little or no tax.
Charitable Donation
Donating a fully depreciated asset avoids triggering recapture, but the charitable deduction is limited. When donated property would produce ordinary income if sold, the deduction is reduced by that potential ordinary income. For a fully depreciated Section 1245 asset, the deduction is generally limited to adjusted basis, which is zero. Fully depreciated real property can fare somewhat better because the unrecaptured Section 1250 portion may support a larger deduction, but the rules are complex enough to justify professional guidance.
Where the Sale Goes on Your Return
Report the sale on Form 4797, Sales of Business Property.14Internal Revenue Service. About Form 4797, Sales of Business Property You enter acquisition date, sale date, sale price, original cost, and total depreciation claimed.
Part III handles depreciation recapture and calculates how much of the gain is ordinary under Section 1245 or Section 1250. That ordinary amount transfers to your Form 1040.15Internal Revenue Service. Instructions for Form 4797 (2025)
Part I handles any remaining gain that qualifies as Section 1231 gain, including the annual netting and the five-year lookback. A net gain flows to Schedule D as long-term capital gain; a net loss transfers back to Form 1040 as an ordinary loss. Schedule D then combines everything and applies the appropriate rates, with unrecaptured Section 1250 gain calculated at the 25% maximum on the Schedule D worksheet. For installment sales, Form 6252 tracks payments and coordinates with Form 4797 so recapture lands in the year of sale while any remaining gain spreads across future years.