Unrecaptured Section 1250 Gain: The 25% Tax Rate on Real Estate Depreciation

What it is

Unrecaptured Section 1250 gain is the portion of a real estate sale gain that equals the straight-line depreciation you claimed (or could have claimed) on the property. It is a category of long-term capital gain — not ordinary income — but it is taxed at a special maximum federal rate of 25%, rather than the lower 0%, 15%, or 20% rates that apply to regular long-term capital gains.

The term comes from IRC Section 1250, which governs real property depreciation recapture. 'Unrecaptured' refers to the fact that most of this gain is not taxed as ordinary income — it escapes the ordinary-income treatment of true Section 1250 recapture because modern MACRS requires straight-line depreciation. Instead, it is 'captured' at the 25% maximum rate, which is a middle ground between ordinary rates and the lower capital-gains rates.

Why it exists: the logic behind the 25% rate

When you own rental real estate, depreciation deductions reduce your taxable income each year at your full ordinary rate — potentially 37% for high earners. At sale, the IRS wants to reclaim some of that tax benefit. Congress chose not to claw it all back at full ordinary rates; instead it created the unrecaptured Section 1250 gain concept, which caps the rate on the depreciation portion at 25%.

This is a deliberate policy tradeoff. If you deducted depreciation at 37% during the holding period and now owe only 25% on the way out, you permanently saved 12 percentage points on that portion — a real economic benefit for holding real estate. The 25% rate is the price for that benefit, and it applies even if your ordinary rate would be lower (though in that case you pay your ordinary rate, not the cap).

The 25% figure is a maximum, not a flat rate

Unrecaptured Section 1250 gain is taxed at your ordinary rate up to a ceiling of 25%. If your ordinary rate is 22%, the gain is taxed at 22%. Only taxpayers whose ordinary rate exceeds 25% actually hit the cap. A retiree in the 12% bracket selling a rental would owe 12% on the unrecaptured 1250 gain, not 25%.

This interaction with the bracket stack is why the year you sell matters. Selling in a low-income year — retirement, a sabbatical, a year with large business losses — can pull the effective rate on the recapture portion well below 25%. Coordinate the sale year with your other income to minimize this layer.

How to compute it: the Unrecaptured Section 1250 Gain Worksheet

The IRS provides a worksheet in the Schedule D instructions titled the Unrecaptured Section 1250 Gain Worksheet. You need to complete it whenever you have a gain from selling real estate for which you claimed depreciation.

The key inputs are: (1) the total depreciation allowed or allowable on the property — this includes depreciation you claimed and depreciation you could have claimed even if you skipped it; (2) the property's total long-term gain before any exclusion. The worksheet computes the unrecaptured Section 1250 gain as the lesser of the total depreciation or the total gain, then determines the tax on that amount at a maximum of 25%. The remaining gain (appreciation above your original cost) is taxed at the standard 0/15/20% long-term capital gains rates.

If you had a cost segregation study that reclassified some components as Section 1245 personal property, those components are not included in unrecaptured Section 1250 gain — they have their own recapture as ordinary income, which is worse than 25%. The worksheet covers only the Section 1250 real property building portion.

A worked example: the tax in dollars

You bought a residential rental building for $280,000, allocated $60,000 to land (non-depreciable) and $220,000 to the building. Over 8 years you claimed $64,000 of straight-line depreciation, reducing your adjusted basis to $216,000 ($280,000 − $64,000 = $216,000). You sell for $400,000, paying $25,000 in selling costs, for an amount realized of $375,000. Your total gain is $375,000 − $216,000 = $159,000.

Of that, $64,000 is unrecaptured Section 1250 gain (the depreciation you took) and $95,000 is regular long-term capital gain (the appreciation). If you are in the 32% ordinary income bracket, the $64,000 of unrecaptured gain is taxed at 25% (the cap applies) = $16,000. The $95,000 of regular capital gain is taxed at 15% = $14,250. Federal tax on the sale: $30,250. Add 3.8% NIIT if your income exceeds the threshold ($200,000 single / $250,000 MFJ) and state tax to get the full picture.

True Section 1250 recapture vs. unrecaptured Section 1250 gain

These two concepts are often confused but are distinct. True Section 1250 recapture is ordinary income — it applies to depreciation taken in excess of straight-line. Because MACRS has required straight-line depreciation on residential and commercial buildings placed in service after 1986, most modern rental properties have zero additional (excess) depreciation and therefore zero true 1250 ordinary-income recapture.

Unrecaptured Section 1250 gain is the broader category: the straight-line depreciation portion of the gain, taxed at up to 25% as a capital gain, not ordinary income. Virtually all modern real estate sales generate unrecaptured 1250 gain but no true 1250 recapture. This is why you see the 25% rate rather than the seller's full 37% marginal rate — the IRS is treating straight-line depreciation leniently, at a capital gain rate rather than an ordinary rate.

NIIT, state tax, and the all-in rate

The 25% cap is a federal income tax ceiling. Two more layers can stack on top. The 3.8% Net Investment Income Tax applies to the gain (including both the unrecaptured 1250 portion and the regular capital gain) for taxpayers with MAGI above the thresholds. This pushes the effective federal ceiling on the recapture slice to 28.8%. Most states also tax the entire gain as ordinary income with no special cap, so in California (13.3% top rate) the all-in combined rate on the depreciation portion could approach 42%.

These stacked rates are why investors who have built large portfolios with significant accumulated depreciation often plan aggressively around the sale. A 1031 exchange defers the entire bill; holding until death eliminates it via step-up in basis.

How to reduce or eliminate it

Three strategies address unrecaptured Section 1250 gain directly. A 1031 like-kind exchange defers the gain — including the unrecaptured 1250 portion — into the replacement property. The deferred gain is preserved until you eventually sell without exchanging. Hold until death: heirs receive a step-up in basis to fair market value under IRC Section 1014, which erases the accumulated depreciation and the unrecaptured 1250 gain permanently. This is the ultimate exit for long-term investors.

A charitable remainder trust (CRT) or a direct charitable donation of appreciated property can reduce or eliminate the gain — the charity's tax-exempt status means no income tax is recognized on the appreciation or the depreciation history, and you receive a charitable deduction for the fair market value. An installment sale spreads the regular capital gain over years, but the unrecaptured Section 1250 gain is still recognized as payments come in (not all accelerated into year one unless you elect otherwise), which can smooth the rate impact.

A second example: selling in a low-income year

Rate timing changes the bill because 25% is only a ceiling. Suppose a retired couple with $60,000 of other taxable income sells a rental with $80,000 of unrecaptured Section 1250 gain and $40,000 of regular long-term capital gain. Their ordinary bracket sits at 12%, so the unrecaptured 1250 gain is taxed at their ordinary rate of 12%, not the 25% cap — about $9,600 rather than $20,000. Part of the regular capital gain may even fall in the 0% long-term bracket.

The same sale in a peak-earning year, when the couple is in the 32% bracket, would tax the $80,000 at the full 25% cap ($20,000) plus 3.8% NIIT. The timing difference is over $13,000 of federal tax on identical economic gain. This is why coordinating the sale year with retirement, a sabbatical, or a year with offsetting losses is one of the highest-value moves available on a rental disposition.

How partnerships and LLCs pass through the 1250 gain

If you own rental real estate through a partnership or multi-member LLC, the unrecaptured Section 1250 gain is computed at the entity level and reported to you on Schedule K-1, typically in box 9c. You carry that figure to your own Unrecaptured Section 1250 Gain Worksheet, where it is combined with any directly held real estate gains. The 25% maximum rate then applies at your individual level based on your own bracket.

A special rule applies to the sale of a partnership interest: when you sell an interest in a partnership that holds depreciated real property, a portion of your gain can be recharacterized as unrecaptured Section 1250 gain under the look-through rules of Section 1(h), even though you sold an interest rather than the underlying building. This surprises many sellers who expect the entire gain on a partnership interest to be ordinary long-term capital gain.

Common mistakes in computing and reporting it

The most frequent error is forgetting depreciation you were entitled to take. The worksheet uses depreciation 'allowed or allowable,' so even years you skipped the deduction still generate unrecaptured 1250 gain. A second error is including land or Section 1245 components in the 1250 figure — land is not depreciated, and cost-segregated personal property has its own ordinary recapture that should not be swept into the 25% category.

A third mistake is assuming the 25% rate always applies; it is a ceiling, and taxpayers below the 25% ordinary bracket pay their lower rate. Finally, sellers often forget that suspended passive losses released at sale can offset the gain, including the unrecaptured 1250 portion, reducing the amount actually subjected to the 25% rate.

Frequently asked questions

What is unrecaptured Section 1250 gain?

The portion of your real estate sale gain equal to the straight-line depreciation you took (or could have taken). It is taxed at a maximum federal rate of 25%, lower than ordinary income rates but higher than the standard capital gains rates.

Is unrecaptured Section 1250 gain ordinary income?

No — it is a category of long-term capital gain taxed at a special maximum rate of 25%, not your full ordinary income rate. True ordinary-income recapture under Section 1250 (for excess depreciation) is rare in modern real estate sales.

What form reports this?

The Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, with the result flowing to the Schedule D Tax Worksheet and then to Form 1040.

Does the 3.8% Net Investment Income Tax stack on top?

Yes, for taxpayers above the MAGI thresholds ($200,000 single / $250,000 MFJ), the NIIT can add 3.8% on top of the 25% recapture rate.

Can a 1031 exchange avoid it?

A 1031 exchange defers — not eliminates — unrecaptured Section 1250 gain. It carries into the replacement property and becomes due when you eventually sell without exchanging. A step-up in basis at death can permanently eliminate it.

Where does unrecaptured Section 1250 gain appear on a K-1?

For real estate held in a partnership or multi-member LLC, it is reported to you on Schedule K-1, generally in box 9c. You carry it to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

Does the 25% rate always apply to my depreciation?

No. The 25% figure is a maximum. If your ordinary income tax bracket is below 25% — say 12% or 22% — the unrecaptured Section 1250 gain is taxed at that lower ordinary rate instead of the cap.

Sources

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

Unrecaptured Section 1250 Gain Explained