Understanding Section 1250: Taxation of Depreciated Real Property

Section 1250 of the U.S. Internal Revenue Code governs how the IRS taxes gains from the sale of depreciated real estate, such as commercial buildings and rental properties. If the property was depreciated using an accelerated method which front-loads deductions and the total depreciation exceeds what straight-line depreciation would have allowed, the excess portion is taxed as ordinary income, not capital gains.

Key Implications for Investors

• Applies primarily to pre-1986 properties, since the IRS now mandates straight-line depreciation for most real estate
• Only the excess depreciation over the straight-line amount is recaptured as ordinary income
• Certain transactions—like gifts, inheritance, or like-kind exchanges—are exempt from Section 1250 taxation

Example Scenario

An investor buys a property for $800,000 and claims $120,000 in accelerated depreciation over five years. If straight-line depreciation would have totaled $100,000, then $20,000 of the gain is taxed as ordinary income, while the remaining gain is taxed at capital gains rates.

Section 1250 of the U.S. Internal Revenue Code governs how gains from the sale of depreciable real property such as commercial buildings, rental units, and barns are taxed. If the property was depreciated using an accelerated method, and the total depreciation exceeds what straight-line depreciation would allow, the excess portion is taxed as ordinary income, not capital gains.

What’s Excluded

Land, tangible personal property, and intangible assets are not subject to Section 1250 rules.

When It Applies

• Accelerated depreciation creates larger early deductions
• Upon sale, the IRS compares actual depreciation to straight-line depreciation
• The difference is taxed as ordinary income, up to the amount of actual gain realized

Why It’s Rare Today

Since 1986, the IRS has required straight-line depreciation for most real estate, making Section 1250 recapture uncommon in modern transactions.

Exempt Transactions

No Section 1250 tax applies if the property is:

• Gifted
• Transferred at death
• Sold via a like-kind exchange
• Disposed of through other exempt methods

Consider an investor who purchases a $800,000 commercial property with a 40-year useful life. After five years, they use accelerated depreciation to claim $120,000 in deductions, reducing the cost basis to $680,000.

If the property is sold for $750,000, the investor realizes a $70,000 taxable gain.

• Straight-line depreciation over five years would have totaled $100,000
• The excess $20,000 in depreciation is taxed as ordinary income under Section 1250
• The remaining $50,000 is taxed at capital gains rates

Now, suppose the investor sells the property for $690,000, generating only a $10,000 gain. In this case, Section 1250 limits the recapture to the actual gain realized, meaning only $10,000 is taxed as ordinary income even though the excess depreciation was $20,000.

This example illustrates how Section 1250 depreciation recapture is capped by the actual profit from the sale, protecting sellers from over-taxation when gains are modest.

Section 1250 of the Internal Revenue Code governs how gains from the sale of depreciated real property are taxed. If accelerated depreciation exceeds what would have been allowed under the straight-line method, the excess portion is taxed as ordinary income, not capital gains.

Although this rule is less common today due to IRS requirements mandating straight-line depreciation for real estate placed in service after 1986 it remains critical for real estate investors using legacy or accelerated methods. Understanding how depreciation strategies affect taxable gains can significantly influence the net proceeds from a property sale and shape long-term investment planning.