Section 1245 vs 1250 Property: Recapture, Lookback, and NIIT

Section 1245 property is depreciable personal property used in a business — equipment, machinery, vehicles, furniture — and when you sell it, every dollar of prior depreciation comes back as ordinary income at rates up to 37%. Section 1250 property is depreciable real property, mainly buildings and their structural components, and the depreciation-related portion of your gain is generally taxed at a maximum rate of 25%.¹ That rate spread is the whole reason the distinction matters. On the same dollar of recaptured depreciation, the difference between Section 1245 vs 1250 property treatment can move the tax bill by twelve percentage points or more.

What Falls Under Section 1245

Section 1245 covers tangible personal property you use in a trade or business and depreciate. Machinery, office furniture, computers, delivery trucks, and manufacturing equipment are the core examples. The section also reaches some categories that surprise people: single-purpose agricultural and horticultural structures, petroleum storage facilities, and railroad grading or tunnel bores.¹ Tangible real property used for a manufacturing, production, or extraction function — as opposed to serving as a general-purpose building — can also qualify.

Amortizable intangibles get pulled in too. Goodwill, patents, customer lists, and other Section 197 intangibles are treated as Section 1245 property when you dispose of more than one of them in the same transaction or a series of related transactions.² And any amount you expensed under Section 179 counts as depreciation for recapture purposes, so the write-off returns as ordinary income when you sell.³

What Falls Under Section 1250

Section 1250 is the catch-all for depreciable real property that isn’t Section 1245 property. In practice, that means buildings and their structural components: commercial office buildings, retail spaces, warehouses, apartment buildings, and residential rentals.¹ Land itself never qualifies, because land isn’t depreciable.

Qualified improvement property — interior improvements to nonresidential buildings such as flooring, interior walls, and lighting — is Section 1250 property as well. That classification carries a wrinkle once bonus depreciation enters the picture, covered below.

How the Recapture Math Actually Differs

Section 1245 recapture is blunt. When you sell at a gain, the recapture amount equals the lesser of your total gain or the total depreciation (including bonus depreciation and Section 179 expensing) you claimed on the asset.² That amount hits your return as ordinary income at your marginal rate, which reaches 37% in 2026.⁴ The IRS looks at depreciation “allowed or allowable,” so if you could have depreciated an asset but didn’t, you still owe recapture as if you had.⁵

A worked example. You buy a machine for $50,000, claim $40,000 in depreciation, and sell for $55,000. Adjusted basis is $10,000. Total gain is $45,000. Under Section 1245, $40,000 is ordinary income. The remaining $5,000 is Section 1231 gain and can qualify for long-term capital gains treatment.

Section 1250 works differently. It originally targeted only accelerated depreciation, recapturing as ordinary income the portion that exceeded straight-line.⁶ Since the Tax Reform Act of 1986 forced most real property onto straight-line, there is usually no excess to recapture as ordinary income on buildings placed in service after 1986.¹

Instead, the straight-line depreciation you took becomes “unrecaptured Section 1250 gain.” That amount, up to your total gain, is taxed at a maximum rate of 25%.⁷ If your ordinary rate is lower, you pay the lower rate; the 25% figure is a ceiling. Gain beyond the depreciation amount and over your original cost falls into standard long-term capital gains rates of 0%, 15%, or 20%.

The same numbers, run through Section 1250: you buy a rental building (excluding land) for $300,000, claim $80,000 in straight-line depreciation, and sell for $350,000. Adjusted basis is $220,000, gain is $130,000. The first $80,000 is unrecaptured Section 1250 gain at up to 25%. The remaining $50,000 is long-term capital gain. Run through Section 1245, that same $80,000 would be ordinary income at up to 37%. That is the practical gap between the two sections.

The Bonus Depreciation Trap on Real Property

The return of 100% bonus depreciation in 2026 disturbs the tidy Section 1250 picture.⁸ On Section 1245 property, bonus depreciation doesn’t change the recapture answer, because all of it was heading to ordinary income anyway. On Section 1250 property, it does.

Section 1250 recaptures depreciation in excess of straight-line as ordinary income. Straight-line produces no excess, which is why buildings usually escape the ordinary rate. Bonus depreciation, by definition, is in excess of straight-line. Claim 100% bonus on qualified improvement property, and the gap between what you wrote off and what straight-line would have allowed becomes “additional depreciation” — recaptured as ordinary income when you sell.⁹

Say you spend $200,000 on interior improvements to your office building and claim 100% bonus. Straight-line over 15 years would have given roughly $13,333 in year one. The other $186,667 is additional depreciation. Sell the building two years later at a gain, and that $186,667 is recaptured at ordinary rates, not the 25% you might have expected for real property.

Hybrid Sales and Cost Segregation

Selling a commercial building almost never involves just one section. A single sale bundles Section 1250 property (the building shell and structural components), Section 1245 property (specialized equipment, certain electrical and plumbing systems, removable fixtures), and non-depreciable land. Proceeds must be allocated across the components, and each piece follows its own recapture rules.

Cost segregation is the analysis that does the allocation. Engineers and tax professionals walk the property and reclassify components onto shorter depreciation schedules — often 5 or 7 years rather than the 27.5-year residential or 39-year nonresidential life that applies to the building shell.¹ Dedicated electrical wiring for manufacturing equipment, process piping, and HVAC installed solely for production are common reclassifications into Section 1245.

The upside is faster deductions during ownership. The downside arrives at sale: every dollar reclassified as Section 1245 property faces full ordinary-income recapture instead of the 25% unrecaptured Section 1250 rate. The trade-off usually favors cost segregation for long holds, where the time value of earlier deductions outweighs the eventual recapture. Short holds deserve closer math.

Rules That Change the Answer

Extra Recapture for C-Corporations

C-corporations lose part of the Section 1250 advantage. Under Section 291, a C-corp must treat 20% of the difference between full Section 1245 recapture and actual Section 1250 recapture as ordinary income.¹⁰ In practice, the IRS asks how much would be ordinary if the building were treated as equipment, then pulls 20% of the gap into ordinary income. The rule does not apply to S-corporations, partnerships, or individuals.

The Section 1231 Five-Year Lookback

Gain that survives recapture typically becomes Section 1231 gain, which converts to long-term capital gain when your annual Section 1231 gains exceed losses. The catch: current Section 1231 gains are recharacterized as ordinary income to the extent you had net Section 1231 losses in the prior five tax years that weren’t already recaptured.¹¹ Losses at ordinary rates followed by gains at capital rates isn’t a trade the IRS lets you make.

The 3.8% Net Investment Income Tax

Higher-income taxpayers may owe an additional 3.8% Net Investment Income Tax on gains from investment or rental property. It applies once modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), and those thresholds are not adjusted for inflation.¹² Both Section 1245 recapture income and unrecaptured Section 1250 gain from rentals can be subject to it, pushing effective maximums to 28.8% on unrecaptured Section 1250 gain and 40.8% on Section 1245 recapture. Gain from property in an active trade or business where you materially participate generally escapes the NIIT.

Transactions That Defer or Erase Recapture

Not every disposition triggers recapture at all.

Gifts. Transferring Section 1245 or Section 1250 property as a gift doesn’t trigger recapture for the donor. The recipient inherits the donor’s basis and depreciation history, and the recapture liability travels with the property.

Transfers at death. Death erases recapture. Basis is stepped up to fair market value on the date of death, wiping out accumulated depreciation.¹³ The heir starts fresh.

Like-kind exchanges. A Section 1031 exchange defers both the gain and the recapture, which carries over into the replacement property. Cash or non-like-kind property received as boot triggers recognition up to the boot amount, and recapture applies to that recognized gain first.¹⁴

Installment sales. No deferral for recapture. All Section 1245 and Section 1250 recapture must be recognized in the year of sale, regardless of when payments arrive.¹⁵ Only gain above the recapture can be spread over the installment period. A seller structuring an installment sale for cash flow reasons can face a year-one tax bill that dwarfs the down payment.

Reporting on Form 4797

Both sections flow through Form 4797, Sales of Business Property. Part III handles the recapture computation. Section 1245 property runs through Line 25; Section 1250 property uses Line 26, where you calculate any additional depreciation above straight-line that gets recaptured as ordinary income.⁹ For Section 1250 property depreciated only on the straight-line method with no bonus, Line 26 typically produces zero. Unrecaptured Section 1250 gain, at the 25% maximum, is computed separately on the Schedule D worksheet. A hybrid sale needs separate Part III entries for the Section 1245 and Section 1250 components; the form won’t combine them for you.

1
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
2
Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property
3
Internal Revenue Service. Instructions for Form 4562 (2025)
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Internal Revenue Service. Depreciation and Recapture
6
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
7
Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed
8
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
9
Internal Revenue Service. Instructions for Form 4797 (2025)
10
Office of the Law Revision Counsel. 26 U.S. Code 291 – Special Rules Relating to Corporate Preference Items
11
Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions
12
Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax
13
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
14
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
15
Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets