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When commercial real estate or a rental property is sold at a profit, taxes have to be paid on the gain. The tax rate for that gain is different for an unrecaptured Section 1250 gain than it is for the typical long-term capital gain rate that is based on your regular tax bracket.
Unrecaptured Section 1250 gain is the portion of a capital gain related to the amount a property has already been depreciated. Any portion of the sale price of real estate that was previously depreciated is subject to a higher capital gain rate, which is usually 25%. Unrecaptured Section 1250 gain only applies to depreciable real estate, such as commercial real estate and residential rental properties.
For example, if an investor purchases an income property for $200,000 and has claimed $50,000 for depreciation deductions, the adjusted cost basis is now $150,000. If the investor then sells that property for $250,000, there is a total capital gain of $100,000 over the adjusted basis. The $50,000 of that gain that is a result of the depreciation that has been claimed on the property is the unrecaptured Section 1250 gain. The Internal Revenue Service (IRS) requires the unrecaptured gain to be recaptured and taxed at the 25% capital gains tax rate, while the other $50,000 that was a gain over the original purchase price is taxed at the normal long-term capital gain rates. This simplified example is demonstrated in the table below.
| Purchase price | $200,000 |
|---|---|
| Claimed depreciation allowance | ($50,000) |
| Adjusted cost basis | $150,000 |
| Sale price | $250,000 |
| Unrecaptured Section 1250 gain | $50,000 |
| Long-term capital gain | $50,000 |
| Total capital gain | $100,000 |
Frequently asked questions about unrecaptured Section 1250 gain
What is a Section 1250 property?
A Section 1250 property is any real property that is used for business purposes. This includes buildings and land.
Are rental properties subject to unrecaptured Section 1250 gains?
Yes, since rental properties are depreciable they are subject to unrecaptured Section 1250 gains, so any depreciation must be recaptured when the property is sold.
Is vacant land subject to unrecaptured Section 1250 gains?
No, vacant land is not depreciable, so there is no depreciation to recapture. Capital gains on vacant land only occur when there is an actual profit from the sale.
How can I reduce unrecaptured Section 1250 gains?
Unrecaptured Section 1250 gains can be offset by capital losses. For a capital loss to offset a capital gain, they both must be either a short-term capital gain or a long-term capital gain.
What's the difference between the unrecaptured Section 1250 gain tax rate and the long-term capital gain tax rate?
Unrecaptured Section 1250 gain is normally taxed at a flat 25%, while the long-term capital gains tax rate is based on the taxpayer's ordinary taxable income
| Long-Term Capital Gains Rate | Single Filer | Married Filing Jointly | Head of Household | Married Filing Separately |
|---|---|---|---|---|
| 0% | $0 - $39,375 | $0 - $78,750 | $0 - $52,750 | $0 - $39,375 |
| 15% | $39,376 - $434,550 | $78,751 - $488,850 | $52,751 - $461,700 | $39,376 - $244,425 |
| 20% | $434,551 + | $488,851 + | $461,701 + | $244,426 + |
2019 capital gains tax rates. Data source: Tax Foundation.
Is Section 1250 property different from Section 1231 property?
Section 1250 property isn't different from Section 1231 property; it's a type of Section 1231 property. A Section 1231 property is any type of depreciable property or real property. Section 1250 property is the portion of Section 1231 property that is real property.
What's the difference between Section 1250 property and Section 1245 property?
Both Section 1245 property and Section 1250 property are types of Section 1231 properties. While a Section 1250 asset is real property, a Section 1245 asset is any other type of depreciable property.
| Property type | Section 1231 | Section 1245 | Section 1250 |
|---|---|---|---|
| Machinery | Yes | Yes | No |
| Office equipment | Yes | Yes | No |
| Land | Yes | No | Yes |
| Buildings | Yes | No | Yes |
What is a Section 1231 gain?
A section 1231 gain is a capital gain realized from the sale of either a Section 1245 property or a Section 1250 property. Capital gains and losses from both categories are added to determine the net Section 1231 gain or loss.
What if the property was depreciated using the Accelerated Cost Recovery System (ACRS)?
If the property was put into service before 1986 and has been depreciated using the Accelerated Cost Recovery System, any depreciation taken in excess of straight-line depreciation is subject to tax at the ordinary income tax rate.
Since real estate placed into service in 1986 or after no longer uses the ACRS, it is rare for properties to fall into this category.
Real estate that has been depreciated over several years can end up with a significant unrecaptured Section 1250 gain when it is sold. It's important to understand what your tax liability will be before entering into a contract to sell your property to avoid any unpleasant surprises when it's time to file your taxes.
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