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Section 1245 Recapture Rules: A Complete Guide for Real Estate Investors

By RE Tax Calc Editorial · Published November 4, 2026

When you sell depreciable property at a gain, Section 1245 converts some of that gain back into ordinary income — recapturing the tax benefit of prior depreciation deductions at the same rate they were taken.

Illustration for Section 1245 Recapture Rules
Quick Answer Section 1245 recapture requires you to recognize previously deducted depreciation as ordinary income when you sell depreciable personal property at a gain — the amount recaptured is the lesser of (a) total depreciation taken or (b) the gain on the sale. For real estate investors, it most commonly surfaces on cost-segregation components (5-year, 7-year, 15-year personal property) reclassified from the building.
IRS Rule Under IRC §1245(a)(1), the amount of gain recognized on the sale of §1245 property that must be treated as ordinary income equals the lesser of: (1) the "recomputed basis" of the property (original cost) minus the amount realized, taken as a negative (i.e., the total depreciation allowed or allowable), or (2) the gain on sale. This recapture applies regardless of how long the property was held — even long-term gains on §1245 property are recaptured as ordinary income to the extent of depreciation.

What Section 1245 recapture means

When you deduct depreciation on business or investment property, you are reducing your taxable income at your ordinary income rate. Section 1245 is Congress's mechanism for ensuring that if you later sell the same property at a price that recovers some or all of that depreciation, the tax benefit is "paid back" at ordinary income rates rather than at the lower long-term capital gain rates that would otherwise apply to the sale gain.

The rule is conceptually straightforward: depreciation lowers your adjusted basis in an asset. When you sell at a gain, that gain is partly attributable to the fact that your basis was artificially reduced by the depreciation deductions. Section 1245 reclassifies that portion of the gain — up to the total depreciation deducted — as ordinary income. Any gain above the total depreciation taken is Section 1231 gain, which is treated as long-term capital gain (subject to its own netting rules).

The practical effect for real estate investors is most visible after a cost segregation study that reclassifies portions of a building into shorter-lived personal property. Those components depreciate much faster — often fully in year one with bonus depreciation — and all of that accelerated deduction becomes potential §1245 recapture when the property is eventually sold.

What property is subject to Section 1245

Section 1245 applies to Section 1245 property, defined in IRC §1245(a)(3) as:

Critically for real estate investors: the building itself (27.5-year residential rental property or 39-year nonresidential real property) is Section 1250 property, not Section 1245. The §1245 exposure in a typical real estate sale comes entirely from the personal property and land improvement components, not the structure itself.

Section 1245 vs. Section 1250: the key distinction

Many investors conflate §1245 and §1250 recapture, but they operate very differently:

Section 1245 recaptures all depreciation taken on personal property as ordinary income, up to the gain. It does not matter that the property was held long-term. If you took $80,000 of bonus depreciation on equipment in year one and sell it five years later for a $50,000 gain, all $50,000 is ordinary income under §1245.

Section 1250 applies to real property (the building). It recaptures only the excess of accelerated depreciation over straight-line depreciation. For post-1986 MACRS real property that already uses the straight-line method, there is no excess — which means §1250 recapture as ordinary income is effectively zero for most modern rental buildings.

What investors often call "depreciation recapture" on a building sale is actually the unrecaptured Section 1250 gain — the portion of a §1231 gain attributable to straight-line depreciation on real property, taxed at a maximum capital gain rate of 25% rather than the lower 15%/20% LTCG rates or at ordinary income rates. This is a third concept, distinct from both §1245 recapture and §1250 recapture.

In summary: §1245 → ordinary income; §1250 → ordinary income only on excess depreciation (usually zero post-1986); unrecaptured §1250 → 25% capital gain rate.

The Section 1245 recapture formula

The calculation follows three steps:

  1. Compute the gain: Amount Realized (selling price minus selling costs) − Adjusted Basis (original cost minus accumulated depreciation) = Total Gain
  2. Identify total depreciation allowed or allowable: This is the total of all depreciation deducted — including any bonus depreciation taken in year one. Note that depreciation "allowable" (what you could have deducted) counts even if you forgot to take it, so not claiming depreciation does not eliminate the recapture exposure.
  3. Recapture amount: The lesser of (a) Total Gain or (b) Total Depreciation Taken. This amount is ordinary income. Any gain above this threshold is §1231 gain.

Example of the formula: You bought a piece of equipment for $100,000, deducted $60,000 in depreciation, and have an adjusted basis of $40,000. You sell it for $80,000.

Now change the sale price to $110,000:

Section 1245 in real estate: cost segregation and the sale

For real estate investors, §1245 recapture becomes significant when a cost segregation study has reclassified portions of a building into 5-year, 7-year, or 15-year personal property. These components are depreciated at accelerated rates — or fully expensed via bonus depreciation — and their depreciation is §1245 recapture potential on a future sale.

When you sell the entire property, you must allocate the total sales proceeds between the land, building, and personal property components. The allocation method (typically based on relative fair market values or the original cost segregation allocation) determines how much of the proceeds is attributable to §1245 property and how much flows to the §1250 building.

One critical rule: under IRC §453(i), if you sell on an installment basis (seller financing, contract for deed), the §1245 recapture amount must be recognized in the year of sale — even if you have not yet received enough payments to cover it. The installment method does not defer §1245 recapture; only the remaining §1231 gain can be spread over the payment period.

Common Mistake Investors who took large first-year bonus depreciation on cost-segregation components often assume all of the eventual sale gain will be capital gain. It won't. Every dollar of bonus depreciation on §1245 components creates an equal dollar of §1245 recapture on a future sale. The deduction shifts income from one year to another at the same ordinary rate — the net present value benefit is real, but the recapture eventually arrives.

Worked numeric example: office building with cost segregation

An investor purchases a small office building for $500,000 in 2021. A cost segregation study allocates $80,000 to 5-year personal property (specialized lighting, flooring systems, and certain fixtures) and $420,000 to 39-year nonresidential real property. Land is purchased separately and is not depreciable.

Depreciation taken 2021–2026 (5 years):

Sale in 2026: Total proceeds $600,000. Allocated $55,000 to 5-year components, $545,000 to the building (land excluded from both for this example).

5-year component calculation (§1245):

Building calculation (§1250 / unrecaptured §1250):

Summary of gain character:

Notice that the $80,000 of bonus depreciation taken in 2021 on the 5-year components does not fully recapture as ordinary income at sale — only $55,000 does, because the allocated proceeds for those components ($55,000) limit the gain. The other $25,000 of depreciation effectively reduced the gain (the components sold for less than their original cost) but that portion was not "recaptured" as income because there was no gain on that portion to tax.

Reporting Section 1245 recapture on Form 4797

Section 1245 property sold at a gain is reported on Form 4797 (Sales of Business Property):

When a cost segregation study identifies multiple component classes (5-year, 7-year, 15-year), each class is reported separately on Form 4797 Part III with its own depreciation tally, since the recapture calculation is performed asset-by-asset (or by class if using the general asset account election).

Planning Tip If you are approaching a sale and have §1245 components with zero basis from bonus depreciation, consider whether a 1031 exchange is desirable. The exchange defers the §1245 recapture into the replacement property's adjusted basis. If you eventually sell the replacement property in a year when you have §1231 losses, those losses can offset the recaptured ordinary income — unlike capital gains, §1231 gains that are not offset by losses are ordinary income, but §1231 losses are ordinary losses that fully offset other income. Timing matters.

Section 1245 and 1031 exchanges

A properly executed 1031 like-kind exchange defers — but does not eliminate — §1245 recapture. Here is how it works:

No boot received: When all proceeds are reinvested in like-kind replacement property and no non-like-kind property (boot) is received, the entire gain — including the §1245 recapture potential — is deferred. The replacement property's adjusted basis is reduced by the deferred gain, preserving the recapture potential for a future sale. The §1245 "taint" follows the asset.

Boot received: When the exchange involves boot (cash, debt reduction, or non-like-kind property), §1245 recapture is triggered first, before any §1231 gain, up to the amount of boot. If the boot is $30,000 and §1245 recapture potential is $80,000, $30,000 is recognized as ordinary income in the exchange year, and $50,000 continues to be deferred in the replacement property.

Mixed-use exchanges: Some investors exchange out of residential (§1250) property into a property with more personal property components, and vice versa. The character of the deferred gain generally follows the original property's classification — the §1245 recapture potential from the relinquished property flows into the replacement property's basis, regardless of whether the replacement property itself is §1250 or §1245 in nature.

One final note: IRC §453(i) mandates that §1245 recapture be recognized in the year of sale even on an installment transaction. This means you cannot use seller financing to defer the ordinary income portion of a §1245 gain — that portion hits your return in year one regardless of when cash is received. Only the remaining §1231 gain qualifies for installment reporting on Form 6252.

Frequently asked questions

What is Section 1245 recapture?

Section 1245 recapture requires you to recognize depreciation previously deducted on personal property (and certain other property) as ordinary income when you sell at a gain. The amount is the lesser of total depreciation taken or the gain on sale. It prevents investors from benefiting from deductions at ordinary rates and gains at lower capital gain rates on the same asset.

Does Section 1245 apply to rental property?

It depends on the component. The building itself (27.5-year or 39-year) is Section 1250 property — no §1245. But cost-segregation components reclassified as 5-year or 7-year personal property (appliances, specialized systems, carpeting) and 15-year land improvements are §1245 property. All depreciation taken on those components, including 100% bonus depreciation, is potential ordinary income at sale.

Can I avoid Section 1245 recapture with a 1031 exchange?

A 1031 exchange defers, not eliminates, §1245 recapture. The recapture potential transfers to the replacement property's adjusted basis. With no boot, nothing is recognized at exchange. With boot received, §1245 recapture is triggered first up to the boot amount. Eventually, when replacement property is sold in a taxable transaction, the deferred recapture surfaces.

How is Section 1245 recapture different from Section 1250 recapture?

§1245 recaptures all depreciation taken as ordinary income. §1250 recaptures only excess depreciation above straight-line — which is zero for post-1986 MACRS real property already using straight-line. The 25% "unrecaptured §1250 gain" is a separate concept: a capital gain taxed at 25%, not ordinary income, representing the building's straight-line depreciation.

Where do I report Section 1245 recapture on my tax return?

Report §1245 property on Form 4797, Part III (lines 19–26). The resulting ordinary income flows to Form 4797 Part II and then to Schedule 1 of Form 1040. Any gain above the recapture amount is §1231 gain on Form 4797 Part I, netting against §1231 losses before moving to Schedule D as long-term capital gain.

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.

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