Unrecaptured section 1250 gain is an Internal Revenue Service (IRS) tax provision where previously recognized depreciation is recaptured into income when a gain is realized on the sale of depreciable real estate property.
Unrecaptured section 1250 gains are taxed at a maximum 25% tax rate, or less in some cases. Unrecaptured section 1250 gains are calculated on a worksheet within the instructions for Schedule D, reported on Schedule D, and carried through to the taxpayer’s 1040.
Key Takeaways
- An unrecaptured section 1250 gain is an income tax provision designed to recapture the portion of a gain related to previously used depreciation allowances.
- It is only applicable to the sale of depreciable real estate.
- Unrecaptured section 1250 gains are usually taxed at a 25% maximum rate.
- Section 1250 gains can be offset by 1231 capital losses.
- Section 1250 applies to real property, whereas Section 1245 applies to personal property.
The Mechanics of Unrecaptured Section 1250 Gains
Section 1231 assets encompass all depreciable capital assets held by a taxpayer for more than one year. Section 1231 acts as an umbrella for assets categorized under sections 1245 and 1250, with the latter detailing the tax rate of depreciation recapture.
Section 1250 pertains only to real property, such as buildings and land, whereas personal property, like machinery and equipment, falls under the purview of section 1245, which taxes depreciation recapture as ordinary income.
Unrecaptured section 1250 gains come into play only when there is a net Section 1231 gain. Essentially, capital losses on all depreciable assets can offset unrecaptured section 1250 gains from real estate. Thus, if there’s a net capital loss overall, it reduces the unrecaptured section 1250 gain to zero.
Depreciated real estate incurs a section 1250 gain upon sale, similar to other assets, with the primary variation being the tax rate applied. This gain offsets the benefits of earlier depreciation allowances. While gains from accumulated depreciation are taxed at the section 1250 recapture tax rate, remaining gains adhere to the long-term capital gains rate of 15%.
Example of Unrecaptured Section 1250 Gains
Consider a scenario where a property was originally bought for $150,000, and the owner claimed $30,000 in depreciation. This sets the adjusted cost basis for the property at $120,000. If the property is later sold for $185,000, the owner has an overall gain of $65,000 over the adjusted cost basis.
Since the sale price exceeded the adjusted cost basis that factored in depreciation, the unrecaptured section 1250 gains stem from the excess of the adjusted cost basis over the original purchase price.
Thus, $30,000 of the gain is subject to the unrecaptured section 1250 tax rate, while the remaining $35,000 is taxed at the regular long-term capital gains rate. Here, $30,000 faces up to a 25% tax rate, whereas the rest $35,000 is taxed at a 15% long-term capital gains rate.
Special Considerations
Since the unrecaptured section 1250 gains qualify as a form of capital gains, they can be offset by capital losses. These losses must be reported via Form 8949 and Schedule D, with the offset value depending on whether the loss is short-term or long-term.
To offset a capital gain, both must be determined to be either short-term or long-term. A short-term loss cannot offset a long-term gain, and vice versa.
Examples of Section 1250 Property
Examples of section 1250 property include commercial buildings or residential rental property. Commercial buildings are treated as MACRS 39-year real property, while residential rental property is handled as 27.5-year property.
Strategies to Avoid Depreciation Recapture
Investors can circumvent tax on depreciation recapture by converting a residential property into a primary residence. Additionally, a taxpayer could opt for a 1031 tax-deferred exchange. Furthermore, upon an investor’s death, their heirs generally inherit the property at a stepped-up basis.
Taxation Rates and Calculations
The maximum tax rate for unrecaptured section 1250 gains stands at 25%.
Calculating Section 1250 Recapture
Section 1250 recapture is computed as the lesser of two values: the excess of accelerated depreciation claimed on real property over what would be allowable with a straight-line method, and the gain realized upon disposition.
Triggers for Depreciation Recapture
Depreciation recapture occurs when there is a disparity between an asset’s sale price and its tax basis or adjusted cost basis. This difference is captured by reporting the disparity as ordinary income.
Conclusion
Section 1250 gain is a tax term referring to the taxable gain from the sale of depreciable real property, as detailed in Section 1250 of the IRC. It deals with the tax treatment of depreciation recapture.
When a property owner sells a depreciable asset, the IRS mandates recapture of a portion of the depreciation previously claimed on the property. This amount is taxed at the special Section 1250 recapture tax rate, typically up to 25%.
Related Terms: depreciation, real estate, depreciation recapture, capital gains, Section 1231, Schedule D.
References
- Internal Revenue Service. “Topic No. 409: Capital Gains and Losses”.
- Internal Revenue Service. “About Schedule D (Form 1040), Capital Gains and Losses”.
- Internal Revenue Service. “Publication 544 (2022), Sales and Other Dispositions of Assets”.
- Internal Revenue Service. “Publication 544: Sales and Other Disposition of Assets”, Page 28.
- Internal Revenue Service. “About Form 8949, Sales and other Dispositions of Capital Assets”.
- Internal Revenue Service. “Publication 527 (2022), Residential Rental Property”.
- Internal Revenue Service. “Publication 946 (2022), How To Depreciate Property”.
