Depreciation recapture is the IRS’s way of taking back the tax benefit you received from prior depreciation deductions when you sell a business asset at a gain. The portion of your gain equal to the depreciation you claimed (or were entitled to claim) gets taxed at ordinary income rates up to 37% for equipment and other personal property, or at a maximum 25% rate for real estate, instead of the more favorable long-term capital gains rates of 0%, 15%, or 20%.1Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets Any gain above the depreciation amount is still taxed as long-term capital gain.
Why Recapture Exists
Depreciation lets you deduct the cost of a business asset over its useful life, and each deduction offsets ordinary income that would otherwise be taxed at rates reaching 37%.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Each year’s deduction also lowers the asset’s adjusted basis, the number the IRS uses to measure your gain at sale. Adjusted basis equals what you paid, plus capital improvements, minus all depreciation you’ve deducted.
Without a recapture rule, you could deduct depreciation against ordinary income (saving up to 37 cents per dollar) and then pay only long-term capital gains rates (as low as 0%) on the sale. Recapture closes that gap. The gain attributable to prior depreciation is taxed at a higher rate, and the rate that applies depends on what kind of asset you sold.
Section 1245: Equipment and Personal Property
Section 1245 covers depreciable property that isn’t a building or a structural component: machinery, office furniture, delivery trucks, computers, farm equipment, and similar business assets.3Office of the Law Revision Counsel. 26 US Code 1245 – Gain From Dispositions of Certain Depreciable Property The rule is blunt: the entire gain up to the total depreciation you took is taxed as ordinary income at your full marginal bracket. Only gain above that amount qualifies for long-term capital gains rates.
Say you buy equipment for $50,000 and claim $30,000 in depreciation, leaving an adjusted basis of $20,000. If you sell for $40,000, the total gain is $20,000. The recapture is the lesser of depreciation taken ($30,000) or total gain ($20,000), so the full $20,000 is ordinary income. Sell that same equipment for $60,000, and the gain is $40,000: $30,000 is ordinary income recapture, and the remaining $10,000 is long-term capital gain. You report the ordinary income portion on Form 4797.4Internal Revenue Service. Instructions for Form 4797 – Sales of Business Property
Section 1250: Real Estate
Section 1250 property is depreciable real property that isn’t Section 1245 property: commercial buildings, residential rentals, and their structural components.5Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty Real estate owners get better treatment than equipment owners. Because most real property placed in service after 1986 must use straight-line depreciation, the harsh ordinary income recapture of Section 1245 rarely applies. Instead, accumulated straight-line depreciation on real estate creates “unrecaptured Section 1250 gain,” taxed at a maximum of 25%.6Office of the Law Revision Counsel. 26 US Code 1 – Tax Imposed That’s better than the 37% top ordinary rate but worse than the 20% capital gains ceiling.
The 25% rate applies to the lesser of your total gain or total straight-line depreciation over your holding period. Anything above that is regular long-term capital gain. You track unrecaptured Section 1250 gain on Schedule D using its dedicated worksheet and report it alongside Form 4797.
A concrete example: you buy a commercial building for $500,000, claim $100,000 in straight-line depreciation, and sell for $550,000. The gain is $150,000. The first $100,000 is unrecaptured Section 1250 gain taxed at up to 25%; the remaining $50,000 is long-term capital gain.
The “Allowed or Allowable” Rule
One of the most expensive misconceptions about depreciation recapture is that skipping the deduction avoids the tax. It doesn’t. Recapture applies to the greater of depreciation “allowed” (what you actually claimed) or “allowable” (what you were legally entitled to claim).7Internal Revenue Service. Depreciation and Recapture 3
Own a rental property for ten years and never claim depreciation on your returns? The IRS still reduces your basis by the amount you should have deducted, and you owe recapture tax on that phantom depreciation when you sell. From the IRS’s view, the deduction was available and your failure to take it was a choice. This trips up landlords who self-prepare and taxpayers who deliberately skip depreciation thinking they’re dodging a future bill. Always claim what you’re entitled to, because you’ll owe recapture either way.
How to Calculate the Recapture Amount
The math is the same for equipment and real estate; only the rate on the recaptured portion differs.
- Start with adjusted basis: original purchase price, plus capital improvements, minus total accumulated depreciation (allowed or allowable, whichever is greater).
- Calculate total gain: net sale price after selling expenses, minus adjusted basis.
- Determine the recapture amount: the lesser of total depreciation taken or total gain.
- Apply the rate. Section 1245 property: recapture is ordinary income at your marginal rate, up to 37%. Section 1250 property: recapture is unrecaptured Section 1250 gain at up to 25%.
- Tax the remainder as long-term capital gain at 0%, 15%, or 20% depending on your income.
Report recapture on Part III of Form 4797, with excess gain flowing to Schedule D and Form 8949.8Internal Revenue Service. Instructions for Form 4797
Situations That Catch Sellers Off Guard
Installment Sales
Selling a business asset on installment normally lets you spread capital gain across the years you receive payments. Depreciation recapture doesn’t get that treatment. The entire recapture amount must be recognized as ordinary income in the year of sale, no matter when the cash arrives.9Office of the Law Revision Counsel. 26 USC 453 – Installment Method Sell equipment with $200,000 of accumulated depreciation on a five-year note, and you owe tax on the full $200,000 in year one even if you’ve received only a fraction of the price.10Internal Revenue Service. Topic No. 705, Installment Sales Only gain above the recapture amount qualifies for installment treatment.
Section 179 and Bonus Depreciation Assets
Section 179 and bonus depreciation both let you deduct an asset’s full cost upfront rather than over its useful life. Bonus depreciation returned to 100% for 2026. Big upfront benefits create equally big recapture exposure.
A specific trap: if the business-use percentage of a Section 179 asset drops to 50% or below during its recovery period, you must recapture the excess deduction in the year use drops. The recapture equals the Section 179 amount you claimed minus the depreciation you’d have been entitled to under normal MACRS rules over the same period. It’s reported as ordinary income on Part IV of Form 4797, and your basis is increased by the recapture amount.11Internal Revenue Service. Publication 946 – How To Depreciate Property Note what triggers this: not a sale, just a change in how you use the asset. Buy a vehicle for the business, expense it under Section 179, and start using it mostly for personal driving two years later, and recapture hits.
Cost Segregation Studies
A cost segregation study reclassifies parts of a building (carpeting, cabinetry, specialized electrical, parking lots, landscaping) from Section 1250 property to Section 1245 property, shortening their depreciation schedules and accelerating deductions during ownership. The trade-off arrives at sale. Those reclassified components no longer qualify for the 25% unrecaptured Section 1250 rate; they face full Section 1245 recapture at ordinary income rates up to 37%. If a study accelerated $200,000 of deductions on reclassified components, that whole $200,000 is ordinary income at sale instead of being taxed at 25%. The time value of earlier deductions often still makes the strategy worthwhile, but the eventual recapture cost is part of the calculation.
Home Office and Home Rental Depreciation
If you used part of your home as a rental or home office and claimed depreciation, the Section 121 exclusion ($250,000 single, $500,000 married filing jointly) does not shield the depreciation-related gain. Depreciation adjustments taken after May 6, 1997, are carved out of the exclusion.12Internal Revenue Service. Publication 523 – Selling Your Home Even if your total gain sits well within the exclusion, you still owe the 25% unrecaptured Section 1250 tax on the depreciation portion.
The allowed-or-allowable rule applies here too, with one exception: if you used the IRS simplified home office method (a flat per-square-foot rate), depreciation is treated as zero and your basis isn’t reduced.7Internal Revenue Service. Depreciation and Recapture 3
Transfers That Don’t Trigger Recapture
Gifting a depreciable asset doesn’t trigger recapture for the donor. The recipient inherits both the donor’s adjusted basis and the built-in recapture liability, and will owe the tax when they eventually sell.3Office of the Law Revision Counsel. 26 US Code 1245 – Gain From Dispositions of Certain Depreciable Property
Death is different. When a depreciable asset passes to heirs, its basis steps up to fair market value at the date of death, wiping out accumulated depreciation and the corresponding recapture liability.5Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty The heirs start fresh.
Section 1031 like-kind exchanges defer recognition of gain, including recapture, but only to the extent you don’t receive non-like-kind property. Cash or debt relief (“boot”) that you receive gets taxed under the recapture rules first. Involuntary conversions (insurance proceeds after a fire, flood, or theft, or a condemnation payment) count as dispositions and trigger recapture.13eCFR. 26 CFR 1.1033(a)-1 – Involuntary Conversions; Nonrecognition of Gain
The 3.8% Net Investment Income Tax
Higher earners owe an extra 3.8% Net Investment Income Tax on their depreciation recapture gains. The surtax applies to individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly). Recapture from both Section 1245 and Section 1250 property counts as net investment income for this purpose. The effective ceiling on unrecaptured Section 1250 gain can reach 28.8% (25% plus 3.8%), and the effective ceiling on Section 1245 recapture can reach 40.8% (37% plus 3.8%) for taxpayers in the top bracket above the NIIT threshold.