21.3 Section 1245 (Full Personal Property Recapture) & Section 1250 / Unrecaptured §1250 Gain
Key Takeaways
Under IRC §1245, recognized gain on the disposition of depreciable personal property and amortizable §197 intangibles is recaptured as ordinary income to the extent of the lesser of recognized gain or total prior depreciation/amortization allowed or allowable.
Section 1245 recapture applies strictly to gains and never applies to losses; any recognized gain exceeding the asset's original acquisition cost is treated as Section 1231 gain.
Under IRC §1250, ordinary recapture applies only to additional (accelerated) depreciation in excess of straight-line; because post-1986 MACRS real property must use straight-line depreciation, §1250 ordinary recapture is generally zero on a conventional MACRS building held more than one year and depreciated only straight-line. Expensed components, accelerated deductions, §1245 property, and corporate §291 must be analyzed separately.
For noncorporate taxpayers, straight-line depreciation claimed on real property held > 1 year is treated as Unrecaptured Section 1250 Gain under IRC §1(h)(1)(D) and taxed at a maximum capital gains rate of 25%, while true economic appreciation above original cost is taxed at regular LTCG rates (0%/15%/20%).
Under IRC §291(a)(1), C corporations disposing of depreciable Section 1250 real property must recharacterize 20% of the excess of hypothetical Section 1245 recapture over actual Section 1250 recapture as ordinary income.
Theoretical Foundation: The Tax Benefit Rule & Recapture Mechanics
When a business acquires a depreciable asset, annual depreciation deductions reduce ordinary taxable income dollar-for-dollar, providing substantial tax savings at ordinary rates (up to 37% for individuals and 21% for C corporations). If the taxpayer could subsequently sell the depreciated property at a gain and pay tax at preferential long-term capital gains rates (0%, 15%, or 20%), the tax code would create a massive, unjustified tax arbitrage.
To prevent this abuse, Congress enacted the depreciation recapture provisions under IRC §1245 and IRC §1250. Grounded in the tax benefit doctrine, these rules recharacterize gain realized upon the sale of depreciated business property as ordinary income to the extent the taxpayer previously benefited from depreciation or amortization deductions.
Depreciation Recapture Spectrum:
┌───────────────────────────────────────────────┬───────────────────────────────────────────────┐
│ IRC §1245 (Personal Property) │ IRC §1250 (Real Property) │
├───────────────────────────────────────────────┼───────────────────────────────────────────────┤
│ • Full Recapture of ALL prior depreciation. │ • Recaptures only EXCESS of accelerated over │
│ • Applies to machinery, equipment, autos, │ straight-line depreciation. │
│ §197 intangibles, patents, livestock. │ • MACRS Real Property = \$0 Ordinary Recapture│
│ • Any gain above original cost = §1231 gain. │ (because MACRS real estate is straight-line)│
│ • Noncorporate Taxpayers: Max 25% rate on │ • Noncorporate: Unrecaptured §1250 (max 25%). │
│ recapture? NO! Full ordinary rates (up 37%).│ • C Corporations: IRC §291 20% ordinary cut. │
└───────────────────────────────────────────────┴───────────────────────────────────────────────┘
Section 1245: Full Recapture of Depreciable Personal Property & Intangibles
Under IRC §1245(a)(1), when Section 1245 property is disposed of at a gain, the gain is treated as ordinary income to the extent of all depreciation or amortization deductions allowed or allowable to the taxpayer.
1. Scope of Section 1245 Property (§1245(a)(3))
Section 1245 property includes:
- Tangible Personal Property: Machinery, manufacturing equipment, trucks, automobiles, office furniture, computers, specialized tools, and laboratory fixtures.
- Amortizable Intangibles under IRC §197: Customer lists, purchased goodwill, covenants not to compete, franchises, trademarks, and patents (amortized over 15 years).
- Specialized Real Property Fixtures: Single-purpose agricultural or horticultural structures (greenhouses, milking parlors under §1245(a)(3)(B)), and grain silos or liquid storage tanks used in production.
- Research and Experimental Property: Depreciated under IRC §174/§168.
2. The Section 1245 Recapture Formula
When Section 1245 property is sold, the character of the recognized gain is bifurcated:
Section 1245 Recapture Formula:
Recognized Gain = Amount Realized - Adjusted Basis
1. Section 1245 Ordinary Income = Lesser of:
(a) Recognized Gain, OR
(b) Total Prior Depreciation / Amortization Allowed or Allowable
(includes MACRS, ACRS, §179 expensing, bonus depreciation §168(k))
2. Section 1231 Gain (Capital Treatment) =
Recognized Gain - Section 1245 Ordinary Income
(This represents pure economic appreciation above the original unadjusted cost basis)
3. Critical Section 1245 Principles for the EA Exam
- Never Applies to Losses: Section 1245 never creates, increases, or governs a loss! If an asset is sold for less than its adjusted basis, Section 1245 is completely inapplicable. The entire loss is a Section 1231 loss (if held > 1 year) or an ordinary loss (if held ≤ 1 year).
- All Deductions Included: Prior depreciation subject to recapture includes regular MACRS, additional first-year bonus depreciation under §168(k), Section 179 expensing, and basis reductions for energy credits.
- Inheritance vs. Gift Transfers: Under §1245(b), recapture is generally excused on gifts (transferred to the donee with carryover basis) and completely wiped out upon death (due to stepped-up basis to FMV under §1014). However, like-kind exchanges (§1031) and corporate formations (§351) trigger recapture if boot is received.
Section 1250: Real Property & The MACRS Straight-Line Reality
IRC §1250 governs depreciable real property, such as commercial buildings, residential rental apartments, warehouses, and structural components (roofs, HVAC, wiring, plumbing).
The Statutory Recapture Rule
Under IRC §1250(a), ordinary income recapture is limited strictly to "additional depreciation"—defined under §1250(b)(1) as the excess of actual depreciation claimed over straight-line depreciation.
IRC §1250 Ordinary Recapture = Excess of Accelerated Depreciation over Straight-Line
Why Section 1250 Ordinary Recapture Is $0 for MACRS Real Property
Under the Tax Reform Act of 1986, Congress mandated that all real property placed in service under MACRS must use the straight-line method:
- Residential rental property: 27.5-year straight-line.
- Nonresidential real property: 31.5-year or 39-year straight-line.
- Qualified Improvement Property (QIP): 15-year straight-line.
Because straight-line depreciation claimed never exceeds straight-line depreciation, the "additional depreciation" for any real property placed in service after 1986 is exactly $0! Therefore, on the EA exam, for any sale of MACRS real property held for more than 1 year, Section 1250 ordinary recapture is $0.
Note
The 1-Year Exception (§1250(b)(1)): If Section 1250 real property is held for 1 year or less, the statute dictates that ALL depreciation claimed (even straight-line) is treated as additional depreciation and recaptured as pure ordinary income in Part II of Form 4797.
Unrecaptured Section 1250 Gain for Noncorporate Taxpayers (§1(h)(1)(D))
Although noncorporate taxpayers (individuals, partners, and S corporation shareholders) escape ordinary income recapture on MACRS real property under §1250, they do not receive the lowest capital gains rate on the entire gain.
Under IRC §1(h)(1)(D), Congress created a special capital gains rate bracket known as Unrecaptured Section 1250 Gain:
Unrecaptured Section 1250 Gain Mechanics (Noncorporate Taxpayers):
Total Recognized Gain on MACRS Real Property Held > 1 Year
┌───────────────────────────────────────────────┴───────────────────────────────────────────────┐
▼ ▼
Unrecaptured §1250 Gain Residual §1231 Capital Gain
(Lesser of Recognized Gain OR Straight-Line Depreciation Claimed) (Gain in excess of Original Cost Basis)
│ │
▼ ▼
Taxed at Maximum Capital Gains Rate of **25%** Taxed at Preferential LTCG Rates of **0% / 15% / 20%**
(+ 3.8% Net Investment Income Tax under §1411 if MAGI exceeds thresholds) (+ 3.8% Net Investment Income Tax under §1411 if applicable)
Priority in Section 1231 Netting
Unrecaptured Section 1250 gain flows through the Section 1231 netting process. If the taxpayer has net Section 1231 losses from other asset sales, the loss offsets the 25% unrecaptured Section 1250 gain first before reducing any 20%/15% capital gains, preserving the highest possible tax savings for the taxpayer.
Section 291 Corporate Recapture for C Corporations
Corporations are not eligible for preferential capital gains rates (taxed at a flat 21%). However, corporate taxpayers are subject to a special statutory recapture provision under IRC §291(a)(1) designed to reduce the corporate capital gain benefit:
The IRC §291 Calculation Rule
When a C corporation sells Section 1250 real property held for more than 1 year at a gain, the corporation must treat as ordinary income 20% of the excess of:
- The amount that would have been treated as ordinary income if the asset had been Section 1245 property (which equals all straight-line depreciation claimed, up to the recognized gain), over
- Any actual Section 1250 ordinary recapture (which is $0 for MACRS property).
Section 291 Corporate Recapture Formula:
Section 291 Ordinary Income = 20% x [Lesser of Recognized Gain OR Prior Depreciation Claimed]
Residual Section 1231 Gain = Total Recognized Gain - Section 291 Ordinary Income
Important
Why Character Matters to a C Corporation: Although C corporations face a flat 21% income tax rate on both ordinary income and capital gains, the distinction between Section 291 ordinary income and Section 1231 capital gain is critically important: under IRC §1211(a), a C corporation can deduct capital losses only to the extent of capital gains! Recharacterizing gain as Section 291 ordinary income prevents the corporation from using current or carried-over capital losses to offset that portion of the profit.
Comprehensive Side-by-Side Worked Example: Individual vs. C Corporation Real Estate Disposition
To master these rules for the EA exam, examine the exact tax consequences when an identical commercial real estate disposition is completed by an Individual Sole Proprietor versus a C Corporation:
Property Transaction Profile:
- Asset: Commercial Office Building (39-year MACRS Nonresidential Real Property)
- Date Acquired: January 15, 2018; Date Sold: October 31, 2025 (Held: > 1 year)
- Original Acquisition Cost Basis: \$1,000,000
- Accumulated Straight-Line MACRS Depreciation: \$200,000
- Adjusted Tax Basis at Date of Sale: \$800,000
- Gross Selling Price (Net of Selling Costs): \$1,350,000
-------------------------------------------------------------------------
Total Realized & Recognized Gain: \$1,350,000 - \$800,000 = \$550,000
===========================================================================
SCENARIO A: Sold by Individual Sole Proprietor (Form 1040)
===========================================================================
1. Section 1245 Recapture: \$0
(Building is real property, not personal property)
2. Section 1250 Ordinary Recapture: \$0
(Depreciation was straight-line MACRS; excess depreciation is \$0)
3. Unrecaptured Section 1250 Gain (IRC §1(h)(1)(D)): \$200,000
- Lesser of Recognized Gain (\$550,000) or Depreciation (\$200,000)
- Taxed at a maximum capital gains rate of 25% (plus 3.8% NIIT)
4. Residual Section 1231 Gain (Schedule D LTCG): \$350,000
- Total Gain (\$550,000) minus Unrecaptured §1250 (\$200,000)
- Equals appreciation above original cost (\$1,350,000 - \$1,000,000)
- Taxed at preferential long-term capital gains rates (0% / 15% / 20%)
===========================================================================
SCENARIO B: Sold by C Corporation (Form 1120)
===========================================================================
1. Section 1245 Recapture: \$0
2. Section 1250 Ordinary Recapture: \$0
3. Section 291 Corporate Recapture (IRC §291(a)(1)): \$40,000
- Hypothetical §1245 Recapture = \$200,000 (all depreciation)
- Less: Actual §1250 Recapture = (\$0)
- Net Subject to §291 = \$200,000
- Section 291 Ordinary Income = 20% x \$200,000 = \$40,000
- Reported in Form 4797, Part III, Line 26, flowing to Part II (Ordinary)
4. Residual Section 1231 Gain (Form 4797, Part I): \$510,000
- Total Gain (\$550,000) minus §291 Ordinary Income (\$40,000)
- Flows to Schedule D / Form 1120 (Can absorb corporate capital losses!)
5. Unrecaptured Section 1250 Gain (25% Rate): \$0
(The 25% rate under §1(h) applies exclusively to noncorporate taxpayers)
Precision Tooling Corp (a calendar-year taxpayer) purchased heavy manufacturing equipment in 2021 for $80,000. Through 2025, the corporation claimed $55,000 in total MACRS and Section 179 depreciation deductions, leaving an adjusted basis of $25,000. On December 1, 2025, Precision sold the equipment for $92,000. What is the amount and character of the gain recognized on Form 4797?
$67,000 Section 1231 capital gain, $0 ordinary income
$67,000 ordinary income, $0 Section 1231 capital gain
$55,000 Section 1245 ordinary income, $12,000 Section 1231 gain
$12,000 Section 1245 ordinary income, $55,000 Section 1231 gain
Karen, an individual taxpayer, sells a residential rental apartment building in 2025 for $600,000 that she purchased in 2017 for $400,000. Karen claimed $110,000 in straight-line MACRS depreciation over her ownership period. She has no other asset sales or unrecaptured Section 1231 losses. How is Karen's $310,000 recognized gain taxed?
$110,000 unrecaptured Section 1250 gain taxed at a maximum rate of 25%, and $200,000 long-term capital gain taxed at regular capital gain rates (0%/15%/20%).
$110,000 ordinary income under Section 1250, and $200,000 long-term capital gain taxed at regular capital gain rates.
$22,000 ordinary income under Section 291, and $288,000 long-term capital gain.
$310,000 long-term capital gain taxed entirely at a maximum rate of 20%.
Apex Logistics Inc., a C corporation, sells a commercial warehouse in 2025 for $2,200,000. The warehouse was acquired in 2016 for $1,500,000, and straight-line MACRS depreciation of $350,000 was claimed, resulting in an adjusted basis of $1,150,000. What amount of the recognized gain must Apex Logistics recharacterize as ordinary income under IRC §291?
$0, because Section 1250 ordinary recapture is $0 for MACRS property.
$350,000, because all prior depreciation is recaptured as ordinary income.
$210,000, representing 20% of the total gain.
$70,000, representing 20% of the straight-line depreciation claimed.
Sections you finish are checked off in the contents.