Understanding Section 1250: Taxation of Depreciated Real Property

What is Section 1250?

Section 1250 refers to the tax rules that govern the treatment of gain from the sale or disposition of depreciable real property, such as buildings and structural components. It ensures that certain depreciation is recaptured as ordinary income or taxed at special rates to prevent taxpayers from converting ordinary deductions into lower-taxed capital gains, affecting your overall gain calculation.

This section applies specifically to real property used in business, excluding land and certain property classified under other sections like Section 1245.

Key Characteristics

Here are the most important features of Section 1250 property and its tax implications:

• Property Type: Applies to depreciable real property such as commercial or residential buildings, but excludes land and personal property.
• Depreciation Methods: Typically involves straight-line depreciation under MACRS, which influences recapture rules.
• Recapture Limits: Only "additional depreciation" beyond straight-line is recaptured as ordinary income; the rest may be taxed as unrecaptured Section 1250 gain.
• Tax Rates: Unrecaptured Section 1250 gain can be taxed at a maximum 25% rate, different from ordinary income rates.
• Reporting: Gains and recapture are reported on Form 4797, with unrecaptured gains flowing to Schedule D.
• Depreciation Conventions: The half-year convention for depreciation may impact timing and amounts of allowable deductions.

How It Works

When you sell Section 1250 property, the IRS recaptures depreciation to prevent tax avoidance by converting ordinary income deductions into capital gains. The amount recaptured as ordinary income is limited to the "additional depreciation" — depreciation exceeding what would have been allowed under straight-line methods.

For most properties placed in service after 1986, straight-line depreciation is standard, meaning no additional depreciation and therefore no ordinary income recapture. However, the portion of gain equal to all depreciation taken is taxed as unrecaptured Section 1250 gain at a maximum 25% rate, with remaining gain qualifying for long-term capital gains treatment.

Examples and Use Cases

Understanding Section 1250 in practice helps clarify its impact on your tax liability when selling real estate:

• Straight-Line Depreciation: If you purchase a rental building and apply straight-line depreciation, your gain upon sale will include unrecaptured Section 1250 gain taxed up to 25%, with any excess gain subject to lower capital gains rates.
• Accelerated Depreciation: Properties depreciated before 1987 using accelerated methods may trigger ordinary income recapture on the excess depreciation portion.
• Real Estate Companies: Corporations like Delta that own depreciable property must consider Section 1250 rules when disposing of buildings or facilities.
• Investment Planning: Investors balancing income and tax efficiency may consult guides on best bond ETFs to diversify their portfolios while managing depreciation recapture risks.

Important Considerations

When dealing with Section 1250 property, keep in mind that unrecaptured depreciation can result in a higher tax rate than typical capital gains. Properly tracking your depreciation basis and understanding the impact of different depreciation methods is crucial.

Additionally, factors such as your property's salvage value and applicable depreciation conventions influence your tax outcomes, so it's important to integrate these details into your tax planning strategies.