Depreciation Recapture: Definition and How It Works

Depreciation recapture is the portion of a gain on the sale of a depreciable asset that the IRS taxes as a consequence of prior depreciation deductions. When a taxpayer deducts depreciation over the life of an asset, those deductions reduce the asset's adjusted basis. If the asset later sells for more than its adjusted basis, the IRS recaptures — or reclaims the tax benefit of — those deductions by treating some or all of the gain as ordinary income or at an elevated capital gain rate. The governing code sections are IRC §§1245 and 1250.

How Depreciation Recapture Is Calculated

The calculation starts with adjusted basis:

Adjusted Basis = Original Cost + Capital Improvements − Accumulated Depreciation

If the sale price exceeds adjusted basis, the taxpayer has a gain. That gain is allocated in a specific order:

1. Depreciation recapture: gain up to the amount of accumulated depreciation is recaptured first
2. Capital gain: any remaining gain above original cost (appreciation beyond what was depreciable) is treated as a capital gain

For example: a client buys equipment for $100,000, deducts $60,000 in depreciation (adjusted basis = $40,000), then sells for $90,000. Gain = $50,000. The first $60,000 of accumulated depreciation exceeds the $50,000 gain, so the entire $50,000 is recapture — no capital gain component. If the client instead sold for $120,000, the first $60,000 of gain is recapture and the remaining $20,000 is a §1231 gain (potentially taxed at long-term capital gains rates).

Section 1245 vs Section 1250

The tax treatment of recapture differs by property type:

Section 1245 applies to personal property (equipment, vehicles, machinery) and certain improvements reclassified from real to personal property through a cost segregation study. When these assets are sold, the full amount of prior depreciation is recaptured as ordinary income — no special rate applies.

Section 1250 applies to depreciable real property. Most post-1986 commercial and residential rental property has been depreciated using the straight-line method under MACRS, which means there is no "excess depreciation over straight-line." As a result, §1250 recapture almost never produces ordinary income for modern real estate. Instead, the accumulated straight-line depreciation is taxed as unrecaptured Section 1250 gain at a federal rate capped at 25% (IRC §1(h)(1)(D)) — higher than the 15%–20% preferential rate for most capital gains, but lower than ordinary income rates.

Reporting Depreciation Recapture: Form 4797

Depreciation recapture on business assets is reported on Form 4797 (Sales of Business Property). The form distinguishes between §1245 recapture (Part III, which flows to ordinary income on Schedule 1) and §1250/unrecaptured gain (which flows to Schedule D for capital gain rate treatment). For rental real estate, the unrecaptured §1250 gain also appears on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

Planning Considerations for CPAs

1031 exchange to defer recapture: A like-kind exchange under IRC §1031 defers recognition of both capital gain and depreciation recapture — the accumulated depreciation carries into the replacement property's basis. See How to Execute a 1031 Like-Kind Exchange.

Installment sale treatment: Under IRC §453, sellers who receive payments over time report gain — including recapture — as installments arrive. However, §1245 recapture is accelerated to the year of sale regardless of installment treatment. §1250 unrecaptured gain follows the installment method. See Installment Sale for how the gross profit ratio method allocates gain.

Cost segregation and recapture: Assets reclassified to shorter depreciable lives through cost segregation generate §1245 recapture — taxed as ordinary income — when the building is sold. CPAs must model whether the time value of earlier deductions outweighs the eventual recapture at ordinary rates. See Cost Segregation Studies.

Net Investment Income Tax (NIIT): Depreciation recapture on passive rental activities may also be subject to the 3.8% Net Investment Income Tax under IRC §1411, increasing the effective rate on unrecaptured §1250 gain above 25%.

For a complete walkthrough of recapture calculations on rental property sales, including §1245 vs §1250 allocation and NIIT interaction, see Depreciation Recapture: How to Calculate and Explain It to Clients Selling Rental Property.

Related Terms

• Depreciation — the systematic deduction of an asset's cost that creates the recapture liability at sale
• Capital Gains — the preferential-rate gain above original cost, distinct from recapture
• Passive Activity Loss — suspended passive losses may be freed up and offset recapture income in the year of sale
• Tax Basis — how original basis is set, how depreciation reduces it, and how adjusted basis flows into the gain calculation
• Installment Sale — one method to defer (in part) the recognition of §1250 gain
• Form 4797 — the IRS form for reporting sales of business and depreciable assets
• Unrecaptured §1250 gain — the portion of real estate gain equal to prior straight-line depreciation, taxed at a federal rate of up to 25%
• §1245 recapture — ordinary income triggered by prior depreciation on personal property
• Realized vs. Recognized Gain — the broader framework; depreciation recapture is a category of recognized gain that cannot be deferred by installment treatment (§1245) or avoided in a §1031 exchange

Arvori helps CPAs identify clients with significant depreciation recapture exposure before a sale closes, giving practitioners time to model deferral strategies. See how Arvori supports real estate tax planning.