Section 1245 recapture and Section 1245 of the Internal Revenue Code governs how gains from selling certain depreciated business property are taxed. When you sell a depreciated asset for more than its adjusted basis, the IRS “recaptures” the depreciation you previously claimed and taxes that portion of the gain as ordinary income.
This prevents taxpayers from taking depreciation deductions at ordinary income tax rates and later converting those deductions into lower‑taxed capital gains.
What Counts as Section 1245 Property?
Also section 1245 property includes tangible and intangible personal property used in a trade or business that has been subject to depreciation or amortization. Examples include:
- Machinery and equipment
- Vehicles
- Computers
- Furniture and fixtures
- Certain amortizable intangibles
- Tangible property used in manufacturing, production, transportation, communications, electricity, gas, water, or sewage services
Additionally, buildings and structural components are not Section 1245 property those fall under Section 1250.
How This Works
When you sell Section 1245 property, the IRS compares three key numbers:
- Adjusted basis Original cost minus depreciation taken.
- Recomputed basis Adjusted basis plus all depreciation taken — effectively the original cost.
- Amount realized The sale price (or fair market value in non‑sale dispositions).
Section 1245 recapture equals the lesser of:
- The gain on the sale (amount realized minus adjusted basis), or
- The total depreciation taken (recomputed basis minus adjusted basis).
Also, this recaptured amount is taxed at ordinary income rates, which can reach up to 37% federally.
Additionally, any remaining gain above the recapture amount is treated as Section 1231 gain, taxed at long‑term capital‑gains rates.
Example
Suppose you buy equipment for $100,000 and claim $60,000 of depreciation. Your adjusted basis is $40,000. You sell the equipment for $85,000.
- Gain: $85,000 − $40,000 = $45,000
- Depreciation taken: $60,000
- Recapture: lesser of $45,000 or $60,000 → $45,000 ordinary income
- Remaining gain: $0 (no capital gain)
This example illustrates how depreciation can create a significant tax bill at sale — even when the asset sells for less than its original cost.
Bonus Depreciation and Section 179: Bigger Deductions, Bigger Recapture
Under Section 1245, bonus depreciation and Section 179 expensing are treated as depreciation for recapture purposes.
This means:
- If you fully expense an asset using bonus depreciation or Section 179, your adjusted basis may drop to zero.
- When you sell the asset, the entire sale price may become ordinary‑income recapture.
For businesses that rely heavily on accelerated depreciation, this can create large tax liabilities when assets are sold or traded in.
Why Section 1245 Recapture Exists
Depreciation is meant to reflect the wear and tear of business assets. But it also creates a tax advantage by reducing taxable income. Without recapture rules, taxpayers could:
- Deduct depreciation at high ordinary income rates, then
- Sell the asset and pay lower capital‑gains tax on the gain.
Section 1245 prevents this mismatch by taxing depreciation‑related gains at ordinary rates.
Section 1245 vs. Section 1250: Key Differences
| Feature | Section 1245 | Section 1250 |
|---|---|---|
| Property type | Personal property | Real property (buildings) |
| Recapture amount | All depreciation taken | Excess depreciation over straight‑line (usually zero under modern MACRS) |
| Tax rate | Ordinary income | Ordinary income on excess depreciation; remaining gain taxed at up to 25% (unrecaptured §1250 gain) |
| Common assets | Equipment, vehicles, machinery | Rental property, commercial buildings |
Understanding this distinction is essential for tax planning, especially when cost segregation is involved.
Installment Sales and Section 1245 Recapture
If you sell Section 1245 property using an installment sale, capital gains may be spread over multiple years — but depreciation recapture is taxed immediately, regardless of when payments are received.
This often surprises sellers who expect installment sales to reduce upfront tax liability.
Section 1245 Recapture and 1031 Exchanges
A properly structured 1031 exchange can defer both capital gains and Section 1245 recapture. However:
- If you receive boot (cash or non‑like‑kind property), recapture may still apply.
- Cost segregation can increase the portion of property treated as Section 1245, affecting exchange outcomes.
Strategies to Reduce Section 1245 Recapture
While you cannot avoid recapture entirely, you can reduce its impact:
- Use 1031 exchanges for qualifying assets.
- Time asset sales for lower‑income years.
- Plan depreciation carefully — aggressive cost segregation increases recapture exposure.
- Maintain accurate depreciation records to avoid IRS adjustments.
- Consider trade‑ins where applicable, which may reduce recognized gain.
Final Takeaway
Section 1245 recapture is a critical tax concept for any business that buys and sells depreciable assets. By understanding how recapture works, how it’s calculated, and how to plan strategically, you can avoid costly surprises and optimize your tax outcomes.