Real Estate Tax Calc
What Section 1250 property means
Section 1250 of the Internal Revenue Code governs the recapture of gain from the sale of depreciable real property. When an investor sells a building at a gain, a portion of that gain — specifically the portion attributable to depreciation deductions taken over the holding period — is taxed at a higher rate than regular long-term capital gains. For individuals, this "unrecaptured Section 1250 gain" is taxed at a maximum rate of 25%.
The logic behind §1250 recapture is straightforward: the investor already received a tax benefit from taking depreciation deductions (which reduced taxable income during the holding period). When the property sells, the IRS effectively claws back a portion of that benefit by taxing the gain attributable to depreciation at a premium rate. The faster you depreciated, the larger your §1250 recapture exposure.
To be §1250 property, the asset must meet two criteria: (1) it must be real property (as opposed to personal property, which falls under §1245), and (2) it must be or have been subject to an allowance for depreciation under IRC §167. Buildings meet both criteria. Land fails the second test decisively.
Why land cannot be Section 1250 property
The tax code does not permit depreciation of land, and the reason is both economic and legal. Economically, land does not wear out or become obsolete the way a building, vehicle, or machine does. A building's structure deteriorates over time, systems become outdated, and the building eventually reaches the end of its useful life. Land, absent specific circumstances like contamination or mineral extraction, retains its character indefinitely.
Legally, IRC §167(a) allows a depreciation deduction for property "used in a trade or business" or "held for the production of income" that has a determinable useful life longer than one year. The IRS has consistently interpreted this as excluding land, and the Regulations under §1.167(a)‑2 state explicitly: "The depreciation allowance in the case of tangible property applies only to that part of the property which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence. … The allowance does not apply to land apart from improvements or physical development added to it."
Because land is never subject to a depreciation allowance, it can never qualify as §1250 property. When you sell an investment property and allocate proceeds between land and building, the land's gain bypasses the §1250 recapture analysis entirely and flows directly into the long-term capital gain calculation.
The building IS Section 1250 property
The structure on the land — the residential rental house, the commercial office building, the retail strip mall — is §1250 property. The building's structural components (walls, roof, floor, HVAC, plumbing, and electrical systems that are part of the building) have all been depreciated over their MACRS recovery periods: 27.5 years for residential rental property, 39 years for nonresidential commercial property.
Every dollar of depreciation taken on the building creates potential §1250 gain upon sale. The maximum tax rate on this unrecaptured gain is 25% for individuals (versus 0%, 15%, or 20% for regular long-term capital gains depending on taxable income). Note that for C corporations, §1250 recapture is taxed at ordinary income rates, not the 25% maximum applicable to individuals.
Personal property components reclassified through cost segregation — the 5-year and 7-year assets — are §1245 property, not §1250. §1245 recapture is taxed at ordinary income rates (not 25%), so it is actually more costly per dollar of recapture than §1250 gain. Understanding the §1245/§1250 split matters when planning cost segregation studies or dispositions.
How the land/building split affects your tax at sale
When you sell an investment property, the total realized gain is divided into components based on how each part was (or was not) depreciated:
- Land gain: Sale price allocated to land minus original land basis. Taxed at long-term capital gains rates (0/15/20%). No §1250 analysis needed.
- Building unrecaptured §1250 gain: The portion of building gain equal to accumulated depreciation taken. Taxed at maximum 25% for individuals.
- Building appreciation above cost: The portion of building gain in excess of cost (i.e., the building sold for more than you originally paid for it). Taxed at long-term capital gains rates (0/15/20%).
- §1245 recapture (if any): Gain on short-life personal property components up to prior depreciation. Taxed at ordinary income rates.
A common planning objective is to maximize the land allocation in the purchase price (buying raw land separately from a building reduces depreciable basis and defers recapture) while minimizing land allocation in the sale price (keeping more of the sale proceeds in the lower-rate land bucket reduces tax on appreciation). The IRS requires both allocations to reflect fair market value, so there is limited flexibility, but getting the allocation right on both ends matters.
Worked numeric example
An investor purchases a commercial office building for $1,000,000. Based on an appraisal, $200,000 is allocated to land and $800,000 to the building. The investor holds the property for 10 years and takes straight-line depreciation on the building over 39 years.
Accumulated depreciation over 10 years: $800,000 ÷ 39 × 10 = $205,128 (rounding slightly for the mid-month convention in years 1 and 10)
Adjusted basis at sale: Land $200,000 + Building ($800,000 − $205,128) = $200,000 + $594,872 = $794,872
The investor sells for $1,500,000. Based on an appraisal at sale, $300,000 is allocated to land and $1,200,000 to the building.
Land gain: $300,000 − $200,000 = $100,000 → taxed at 0/15/20% LTCG rates
Building gain: $1,200,000 − $594,872 = $605,128
- Of the $605,128 building gain: $205,128 is unrecaptured §1250 gain → taxed at max 25%
- Remaining building gain: $605,128 − $205,128 = $400,000 → taxed at 0/15/20% LTCG rates
Total gain: $705,128 ($100k land + $605k building), split three ways for tax purposes. The $100,000 land gain never touches the §1250 analysis, regardless of how long the building was depreciated.
For an investor in the 20% long-term capital gains bracket, the blended tax on this transaction would be: ($100,000 + $400,000) × 20% + $205,128 × 25% = $100,000 + $51,282 = $151,282 total federal capital gains tax. The effective rate on the full $705,128 gain is approximately 21.5%.
Cost segregation and the land component
Cost segregation studies reclassify components of a building from long-life (39-year) to short-life (5-, 7-, or 15-year) categories, accelerating depreciation deductions. These studies work entirely within the building's depreciable cost — they cannot reclassify raw land to a depreciable category, because land cannot be depreciated regardless of methodology.
However, cost segregation can — and routinely does — reclassify improvements to land that were bundled into the building's purchase price. Items like parking lot paving, landscaping, irrigation systems, fencing, outdoor lighting, and retaining walls that sit on the land but do not form part of the building structure are reclassified to 15-year land improvements. These are still depreciable (unlike raw land), and 15-year land improvements qualify for bonus depreciation.
The result: cost segregation may reduce the building's depreciable basis slightly (moving components from the building bucket to the land improvement bucket or the personal property bucket), but it never moves value into the non-depreciable land bucket. The allocation between land and depreciable improvements is a separate analysis from the original purchase-price allocation between land and building.
Frequently asked questions
Is land Section 1250 property?
No. Section 1250 property is real property that is or has been subject to an allowance for depreciation. Land cannot be depreciated under IRC §167 or §168, so it is never Section 1250 property. Only the building on the land is §1250 property.
What is Section 1250 recapture on real estate?
When you sell depreciable real property, a portion of the gain equal to prior depreciation is taxed as unrecaptured Section 1250 gain at a maximum rate of 25% for individuals, rather than at the lower long-term capital gains rate. This applies only to the building, not to land.
Is land gain taxed differently than building gain when I sell?
Yes. Land gain is taxed at long-term capital gains rates (0%, 15%, or 20% depending on income). Building gain has two components: the portion equal to accumulated depreciation is taxed at up to 25% as unrecaptured §1250 gain, and any appreciation beyond original cost is taxed at long-term capital gains rates.
Can cost segregation reclassify land to shorter-life property?
No. Raw land cannot be depreciated regardless of cost segregation. However, improvements to the land — landscaping, paving, fencing, irrigation systems — can be reclassified from 39-year building to 15-year land improvements, which are eligible for bonus depreciation. The underlying land itself always remains non-depreciable.
How do I allocate sale proceeds between land and building when I sell?
Use a method that reflects fair market values at the time of sale: a third-party appraisal, a cost segregation study, local assessor records (land-to-total value ratio), or a negotiated allocation in the purchase agreement. The IRS looks for a reasonable, supportable allocation — not one engineered to minimize recapture.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.