Depreciation Recapture: What Happens When You Sell Business Property
When you sell business property at a gain, you might expect the entire profit to be taxed at favorable capital gains rates. However, the IRS has a rule that can turn a significant portion of that gain into ordinary income—taxed at your regular, often higher, tax rate. This rule is called depreciation recapture, and it’s a critical concept for anyone selling depreciable business property.
Here’s what you need to know based on IRS Publication 544 (2025).
What Is Depreciation Recapture?
When you use property in a business, you’re allowed to deduct depreciation each year to recover its cost. Those deductions reduce your adjusted basis in the property, which in turn increases the gain you realize when you sell it.
Depreciation recapture is the IRS’s way of ensuring that the tax benefits you received from depreciation deductions are “recaptured” as ordinary income when you dispose of the property. In essence, you can’t convert ordinary income (the depreciation deductions) into capital gain (the sale profit) simply by holding and depreciating an asset.
The recapture rules are governed primarily by Section 1245 (for personal property) and Section 1250 (for real property).
Section 1245 Property: Personal Property and More
Section 1245 property includes:
- Tangible personal property (machinery, equipment, vehicles, furniture)
- Other tangible property used in manufacturing, production, extraction, or as a research or storage facility
- Certain real property with specific deductions (like the Section 179 expense deduction or amortization of pollution control facilities)
- Single-purpose agricultural or horticultural structures
- Qualified production property (new for 2025, if placed in service after July 4, 2025, under P.L. 119-21)
How the Recapture Works
For Section 1245 property, the gain treated as ordinary income is the lesser of:
- The depreciation and amortization allowed or allowable on the property, or
- The gain realized on the disposition (amount realized minus adjusted basis)
Any gain above the recapture amount is treated as Section 1231 gain (potentially capital gain).
Example: Selling a Business Truck
You bought a light-duty truck for $10,000 in February 2023 and used it 100% for business. Using MACRS and the half-year convention, you claimed:
- 2023: $2,000
- 2024: $3,200
- 2025 (year of sale): $960
Total depreciation: $6,160
You sold the truck in May 2025 for $7,000.
| Calculation | Amount |
|---|---|
| Amount realized | $7,000 |
| Cost basis | $10,000 |
| Depreciation allowed | ($6,160) |
| Adjusted basis | $3,840 |
| Gain realized | $3,160 |
| Gain treated as ordinary income (lesser of $6,160 or $3,160) | $3,160 |
In this case, the entire gain is ordinary income because the depreciation taken exceeds the gain.
What Counts as “Depreciation”?
The recapture amount includes more than just regular depreciation. It also includes:
- Section 179 deductions
- Special (bonus) depreciation allowances
- Amortization of intangibles, leasehold improvements, pollution control facilities, and reforestation costs
- Basis reductions from investment credits or qualified electric vehicle credits
Depreciation Allowed or Allowable
The IRS generally uses the greater of depreciation allowed (what you actually deducted) or allowable (what you could have deducted). However, if you consistently took proper deductions under one method, the amount allowed won’t be increased just because another method would have allowed more.
Important: If you never claimed depreciation, the IRS will still calculate recapture using the straight-line method as if you had.
Section 1250 Property: Real Property
Section 1250 property includes all real property subject to depreciation that is not Section 1245 property—most notably:
- Buildings (office buildings, rental properties, warehouses)
- Structural components (walls, floors, windows, HVAC systems)
- Leaseholds of land or Section 1250 property
The Key Difference: “Additional Depreciation”
For Section 1250 property, recapture is generally limited to additional depreciation—the amount of depreciation claimed above what straight-line depreciation would have been.
Since most real property placed in service after 1986 is depreciated using the straight-line method, there is often no additional depreciation and, therefore, no ordinary income recapture for Section 1250 property. Instead, the gain is treated as Section 1231 gain (capital gain).
However, for older properties or those with accelerated depreciation methods, additional depreciation may exist.
Applicable Percentages
The applicable percentage used to figure ordinary income depends on the type of real property:
| Property Type | Applicable Percentage |
|---|---|
| Nonresidential real property (periods after 1969) | 100% |
| Residential rental property (periods after 1975) | 100% |
| Low-income housing | 100% minus 1% for each full month held over 100 months (zero after 16 years, 8 months) |
Unrecaptured Section 1250 Gain
Even if you have no ordinary income recapture, you may have unrecaptured Section 1250 gain—the portion of your long-term capital gain attributable to depreciation. This gain is taxed at a maximum rate of 25% (rather than the standard 0%, 15%, or 20% capital gains rates).
Special Situations
Like-Kind Exchanges and Involuntary Conversions
If you exchange property in a like-kind exchange or convert it involuntarily, the recapture rules still apply—even if you don’t recognize gain on the exchange. The recapture amount may be limited, but you may still owe ordinary income tax on the depreciation.
Section 1245 Example: You exchange real property with an FMV of $100,000 and a basis of $50,000 for like-kind property worth $60,000 plus $40,000 cash. The gain realized is $50,000, and the gain recognized is $40,000 (the cash). If the property includes Section 1245 property with $10,000 of depreciation and a $0 adjusted basis, the Section 1245 recapture is $10,000—the lesser of the recapture amount or the Section 1245(b)(4) limit ($40,000 gain recognized + $45,000 FMV of Section 1250 property received = $85,000).
Installment Sales
If you report a sale under the installment method, depreciation recapture is taxable in the year of sale, even if you receive no payments that year. The remaining gain is then reported under the installment method.
Gifts
If you give away depreciable property, you don’t report income. However, the donee must take your depreciation into account when calculating recapture if they later sell the property.
Transfers at Death
When you die, depreciable property transferred to your estate or beneficiaries generally does not trigger recapture. The heir receives a stepped-up basis, and no ordinary income is reported on the transfer.
Key Takeaways
- Depreciation recapture converts capital gain into ordinary income to the extent of depreciation deductions you claimed (or could have claimed).
- Section 1245 property (personal property) has stricter recapture rules—all depreciation is subject to recapture.
- Section 1250 property (real property) generally only recaptures “additional depreciation” above straight-line; most post-1986 real property has no ordinary income recapture.
- Unrecaptured Section 1250 gain is taxed at a maximum rate of 25%.
- Keep detailed records of depreciation, improvements, and basis adjustments—you’ll need them to calculate recapture accurately.
Disclaimer: This blog post is a summary of IRS Publication 544 (2025) for informational purposes only. Tax laws are complex and subject to change. Always consult with a qualified tax professional regarding your specific situation