Section 1250 property is depreciable real estate: buildings, rental homes, commercial structures, and the structural components inside them. When you sell it at a profit, the IRS taxes the portion of your gain equal to the depreciation you claimed at a maximum federal rate of 25%, and the rest of the gain at standard long-term capital gains rates.1Internal Revenue Service. Topic No. 409, Capital Gains and Losses That 25% layer, called “unrecaptured Section 1250 gain,” is the tax cost most sellers underestimate.
What Counts as Section 1250 Property
The tax code defines Section 1250 property as any real property that is or has been eligible for depreciation deductions.2Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty In practice, that means commercial office buildings, apartment complexes, warehouses, retail storefronts, single-family rentals, and the structural components inside them: roofing, plumbing, electrical systems, walls. Depreciable land improvements like parking lots, sidewalks, and landscaping can also fall in, though some shift into Section 1245 depending on the depreciation method.
Land itself never qualifies, because land cannot be depreciated. If you buy a rental for $400,000 and allocate $100,000 to land and $300,000 to the building, only the $300,000 building is Section 1250 property. That split matters at sale, because only the building’s depreciation creates recapture exposure.
One wrinkle: if you claim a Section 179 deduction on certain qualifying real property improvements, such as a new roof, HVAC system, fire alarm, or security system in a nonresidential building, the IRS reclassifies that deducted amount as Section 1245 property for recapture purposes. The reclassified portion is taxed as ordinary income, not at the 25% rate.
How the Tax Works When You Sell
Modern real estate uses straight-line depreciation. Residential rental property depreciates over 27.5 years and nonresidential real property over 39 years.3Office of the Law Revision Counsel. 26 US Code 168 – Accelerated Cost Recovery System Because straight-line is mandatory, the original Section 1250 formula (which recaptured only “excess” depreciation above straight-line as ordinary income) almost never produces a tax on modern real estate. What matters instead is unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%.1Internal Revenue Service. Topic No. 409, Capital Gains and Losses
At sale, the IRS splits your profit into layers. The layer equal to the depreciation you claimed is the unrecaptured Section 1250 gain. Anything above that is regular long-term capital gain, taxed at 0%, 15%, or 20% depending on income.
The unrecaptured gain equals the lesser of your total gain or the depreciation you claimed. Here is how that runs on a real transaction:
- Purchase price: $500,000
- Depreciation claimed over the holding period: $100,000
- Adjusted basis at sale: $400,000
- Sale price: $650,000
- Total gain: $250,000
The lesser of $250,000 (total gain) or $100,000 (depreciation) is $100,000, so $100,000 of the gain hits the 25% ceiling. The remaining $150,000 is taxed at your long-term capital gains rate. The recapture tax on the depreciation layer alone comes to $25,000, and that number is what catches sellers who planned only for capital gains rates.
The 25% is a ceiling, not a flat rate. If your marginal rate is lower, the unrecaptured gain is taxed at that lower rate instead. Report the sale on Form 4797, which separates ordinary income recapture, 25% rate gain, and residual capital gain.4Internal Revenue Service. Instructions for Form 4797 (2025) The unrecaptured gain then flows to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.
You Can’t Skip Depreciation to Avoid the Tax
Some owners assume they can dodge recapture by never claiming depreciation. The IRS closed that door. Your basis must be reduced by depreciation “allowed or allowable, whichever is greater.”5Internal Revenue Service. Publication 946 (2025), How To Depreciate Property Allowed means what you actually deducted. Allowable means what you were entitled to deduct, whether you claimed it or not.
Hold a rental for ten years, take no depreciation, and the IRS still reduces your basis by the full amount you could have deducted. At sale, you owe recapture tax on deductions you never took. Claim what you’re entitled to each year.
The 3.8% Surtax Stacks on Top
The 25% ceiling is not the whole story for higher-income sellers. The net investment income tax adds another 3.8% on top when modified adjusted gross income exceeds $250,000 for married couples filing jointly, $200,000 for single filers, or $125,000 for married individuals filing separately.6Internal Revenue Service. Topic No. 559, Net Investment Income Tax Those thresholds are not adjusted for inflation.
Both the unrecaptured Section 1250 gain and the residual long-term capital gain count as net investment income.7eCFR. 26 CFR 1.1411-4 – Net Investment Income For sellers above the threshold, the effective federal rate on the depreciation layer can reach 28.8%, and the residual gain layer can reach 23.8%.
Selling Within a Year Wipes Out the 25% Cap
The favorable treatment applies only if you held the property more than one year. Sell inside twelve months and all depreciation adjustments count as “additional depreciation,” with the corresponding gain taxed as ordinary income.2Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty The remaining profit also loses long-term capital gains treatment because the entire gain is short-term. If you’re near the one-year line, waiting the extra weeks can change the tax dramatically.
C Corporations Pay More
C corporations face an added recapture layer under Section 291. When a corporation sells Section 1250 property, 20% of the difference between what would have been recaptured under Section 1245 rules and what was actually recaptured under Section 1250 rules is treated as ordinary income.8Office of the Law Revision Counsel. 26 US Code 291 – Special Rules Relating to Corporate Preference Items
In practice, because straight-line depreciation produces zero standard Section 1250 recapture, this rule means 20% of total depreciation is taxed as ordinary income. A corporation that claimed $200,000 in depreciation and sells at a gain owes ordinary-income tax on $40,000. An individual owner in the same situation would pay at most the 25% rate on the full $200,000. This is one reason holding real estate inside a C corporation is often less tax-efficient at disposition than holding it individually or through a pass-through.
Ways to Defer or Erase the Tax
Like-Kind Exchanges
A Section 1031 exchange lets you swap one investment property for another of equal or greater value without recognizing gain at the time of the exchange. The unrecaptured Section 1250 gain is not erased; it rolls into the replacement property by reducing its depreciable basis. When you eventually sell the replacement in a taxable transaction, the deferred recapture comes due along with any new depreciation claimed on the replacement.
Successive exchanges can defer the tax indefinitely, which is why 1031s are a cornerstone of real estate tax planning. The trade-off is a lower depreciable basis on each replacement, producing smaller annual deductions than a fresh purchase at full market value would. If you receive cash or other non-like-kind property (“boot”), gain is recognized to the extent of the boot, and that recognized gain is characterized under the recapture rules.
Installment Sales Don’t Defer the Recapture
Spreading a sale across multiple years through an installment agreement doesn’t spread the recapture. The full Section 1250 recapture must be recognized in the year of sale regardless of the buyer’s payment schedule.9Office of the Law Revision Counsel. 26 US Code 453 – Installment Method After that immediate hit, the remaining gain qualifies for installment treatment and is recognized as payments arrive. Unrecaptured Section 1250 gain is taken into account before adjusted net capital gain, so the earlier payments carry the higher rate.10eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain Reported on the Installment Method Budget for the recapture tax in year one even if the first payment barely covers it.
Gifts Pass the Liability; Inheritance Erases It
Gift the property during your lifetime and the recipient inherits your basis and your depreciation history.11Office of the Law Revision Counsel. 26 US Code 1015 – Basis of Property Acquired by Gifts and Transfers in Trust When they sell, they face the same unrecaptured Section 1250 gain you would have owed. No immediate tax, but the full liability travels with the property.
Inheritance works differently. Property acquired from a decedent gets a basis equal to fair market value at date of death.12Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent The step-up wipes out accumulated depreciation, so the heir faces zero unrecaptured Section 1250 gain on a later sale (unless they claim new depreciation after inheriting). For property with a large depreciation balance, the savings can be substantial, which is why some investors deliberately hold heavily depreciated real estate until death.
Pass-Through Reporting
Owning Section 1250 property through a partnership or multi-member LLC taxed as a partnership doesn’t change the character of the gain. Your share shows up on Schedule K-1 (Form 1065) in Box 9c.13Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) The partnership doesn’t pay the tax; each partner reports their share on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.
If the partnership sells the property, the gain appears in Box 9c. If you sell your partnership interest instead, your share of the gain attributable to the partnership’s Section 1250 assets appears under Box 20, Code AD. Either way, the 25% character passes through. S corporation shareholders get equivalent information on their K-1 (Form 1120-S). Watch these boxes closely, because the K-1 amounts flow directly into your Schedule D calculation.
State Taxes Are Separate
The 25% ceiling and the 3.8% surtax are federal only. Most states tax capital gains as ordinary income, and few follow the federal distinction between unrecaptured Section 1250 gain and other capital gains. State rates on this gain run from nothing in states without an income tax to over 13% in the highest-tax states. When you project after-tax proceeds from a real estate sale, leaving out state tax can create a five-figure gap between what you expect and what lands in your account.