Section 1250 Explained: 2025 Guide to Depreciated Real Estate Taxation and Examples

Understanding Section 1250 in 2024

Section 1250 of the U.S. Internal Revenue Code governs how the IRS taxes gains from the sale of depreciated real property. Specifically, it requires that gains exceeding straight-line depreciation be taxed as ordinary income. This rule primarily applies when accelerated depreciation methods have been used on real estate assets.

Key Insights

• Section 1250 mandates ordinary income tax on gains from depreciated real property that surpass straight-line depreciation amounts.
• This provision mainly affects properties depreciated using accelerated methods, such as commercial buildings or rental properties.

The Fundamentals of Section 1250

This section applies to depreciable real estate—like commercial structures, warehouses, barns, and rental units—but excludes land and personal property. When accelerated depreciation is used, larger deductions occur early on, which can lead to higher ordinary income recapture upon sale.

Owners of post-1986 real estate typically use the straight-line method, making Section 1250 recapture less common. Additionally, certain transfers like gifts, inheritances, or like-kind exchanges are exempt from this tax treatment.

Practical Example of Section 1250 Taxation

Imagine an investor purchases a property for $800,000 with a 40-year lifespan. After five years using accelerated depreciation, they've claimed $120,000 in deductions, reducing the cost basis to $680,000.

If they sell the property for $750,000, they realize a $70,000 gain. Since straight-line depreciation over five years equals $100,000, the $20,000 excess depreciation is taxed as ordinary income. The remaining $50,000 gain is subject to capital gains tax rates.

Importantly, recapture as ordinary income cannot exceed the total gain. If the sale price were $690,000, resulting in only a $10,000 gain, only that amount would be taxed as ordinary income, despite $20,000 of excess depreciation.

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