Taxterity research

Selling depreciated property: a section 1245, 1250 and 1231 issue map

Reviewed 2026-09-15 · AI-assisted draft and editing; sources and limitations remain visible for independent review.

Answer: Character is decided in a fixed order, and getting the order wrong produces a plausible answer that is wrong. Ordinary income under section 1245 or section 1250 is computed first and is recognized notwithstanding any other provision of the subtitle. Only what survives that step enters the section 1231 pool. Section 1231(a) then nets the year's gains and losses: a net loss is ordinary, a net gain is long-term capital except that section 1231(c) recharacterizes it as ordinary income up to the taxpayer's non-recaptured net section 1231 losses from the five most recent preceding taxable years. Whatever remains long-term capital gain is then sorted into rate buckets, and this is where unrecaptured section 1250 gain appears. It is not recapture at all: section 1(h)(6) defines it as the amount that would have been ordinary income if section 1250(b)(1) included all depreciation and the applicable percentage were 100 percent, and section 1(h)(1)(E) taxes it at 25 percent, with section 1(h)(6)(B) capping it at the year's net section 1231 gain. For most real property placed in service under the modern recovery system and depreciated on the straight line, section 1250 yields no ordinary income at all, because there is no additional depreciation, and the entire depreciation-driven gain lands in that 25 percent bucket instead.

Ask Taxterity about your own tax issue

Scope

Jurisdiction: United States — federal

Tax periods: Not period-specific; checked 2026-09-15, 2025 returns (Publication 544), QPP placed in service after 2025-07-04

Assumptions

Exclusions

Step 1. Ordinary income first, and it is not optional

Section 1245(a)(1) treats as ordinary income the excess of the lower of recomputed basis or amount realized, over adjusted basis, and says the gain is recognized notwithstanding any other provision of the subtitle. Section 1250(a)(1)(A) does the parallel thing for section 1250 property, applying an applicable percentage to the lower of post-1975 additional depreciation or the excess of amount realized over adjusted basis, with the same override. Nothing about this is elective, and it is computed asset by asset, not on the year's net result.

Section 1245(a)(2) defines recomputed basis as adjusted basis increased by all adjustments reflected in it for depreciation or amortization, whether allowed or allowable to this taxpayer or to any other person. Subparagraph (B) lets a taxpayer who can establish by adequate records or other sufficient evidence that the amount allowed was less than the amount allowable use the lesser allowed amount, which is a records question, not an argument. Subparagraph (C) sweeps in deductions under sections 179, 179B, 179C, 179D, 179E, 181, 190, 193 and 194 by treating them as amortization, so an expensing election taken years earlier comes back as ordinary income here.

Step 2. Know which property is in which bucket

Section 1245(a)(3) lists the categories: personal property; other tangible property, excluding a building or its structural components, used as an integral part of manufacturing, production or extraction or of furnishing transportation, communications, electrical energy, gas, water or sewage disposal services, or constituting a research facility or a bulk storage facility for fungible commodities used in connection with those activities; real property whose basis reflects amortization under the named sections; a single purpose agricultural or horticultural structure; a petroleum storage facility that is not a building or its structural components; railroad grading or tunnel bore; and, as of the 2025 amendment, qualified production property as defined in section 168(n)(2).

Section 1250(c) is residual: section 1250 property is any real property, other than section 1245 property, that is or has been of a character subject to the allowance for depreciation. The two definitions are therefore not parallel and not symmetrical. An asset is tested against the section 1245 list first, and it is section 1250 property only because it failed that test. This is the same classification question a cost segregation study exists to answer, which is why a disposition is the moment an aggressive study is tested.

Step 3. Understand why section 1250 usually produces nothing

Section 1250 recaptures additional depreciation, which section 1250(b)(1) defines, for property held more than one year, as depreciation adjustments only to the extent they exceed what straight line would have produced. Real property placed in service under the modern recovery system is depreciated on the straight line, so there is generally no excess and therefore no additional depreciation to recapture. The applicable percentage in section 1250(a)(1)(B)(v) is 100 percent for all other section 1250 property, but 100 percent of zero is zero.

Publication 544 states the same point from the other direction under the heading Applicable Percentage: for real property that is not residential rental property the applicable percentage for periods after 1969 is 100 percent, and for residential rental property other than low-income housing the percentage for periods after 1975 is 100 percent, with earlier periods at zero. Practitioners who expect a large ordinary recapture number on a commercial building sale are usually thinking of unrecaptured section 1250 gain, which is a different thing and sits two steps later.

Step 4. Net the survivors under section 1231

Section 1231(a)(1) and (a)(2) do the netting: if section 1231 gains exceed section 1231 losses, all of them are long-term capital gains and losses; if they do not, none of them is treated as from the sale or exchange of a capital asset. Section 1231(a)(3) defines the pool as recognized gain on the sale or exchange of property used in the trade or business plus recognized gain from compulsory or involuntary conversion of such property or of a capital asset held more than one year in connection with a trade or business or a profit-seeking transaction. Section 1231(b)(1) defines property used in the trade or business and excludes inventory, property held primarily for sale to customers, certain self-created intangibles, and certain United States Government publications.

Section 1231(a)(4)(C) contains a rule that is routinely missed. Where an involuntary conversion arises from fire, storm, shipwreck, other casualty, or theft, section 1231 does not apply to that conversion at all, whether it produced gain or loss, if for the taxable year the recognized losses from such conversions exceed the recognized gains from them. That is a separate preliminary netting, sometimes called the casualty netting, and it runs before the main pool is assembled.

Step 5. Apply the five-year lookback before celebrating a capital gain

Section 1231(c)(1) treats net section 1231 gain as ordinary income to the extent it does not exceed non-recaptured net section 1231 losses, and section 1231(c)(2) defines those as the aggregate net section 1231 losses for the five most recent preceding taxable years, reduced by amounts already taken into account under paragraph (1) in those years. It is a rolling five-year account, not a one-time adjustment, and it produces ordinary income without any depreciation being involved.

Publication 544 works the mechanics under the heading Nonrecaptured section 1231 losses and states that losses are applied against a net section 1231 gain beginning with the earliest loss in the five-year period. A file that reaches a section 1231 gain without documenting the prior five years has not finished. In practice the lookback is the most common source of an unexpected ordinary income number on an otherwise clean sale.

Step 6. Sort the remaining long-term gain into rate buckets

Section 1(h)(6)(A) defines unrecaptured section 1250 gain as the excess of the amount of long-term capital gain, not otherwise treated as ordinary income, that would be treated as ordinary income if section 1250(b)(1) included all depreciation and the applicable percentage under section 1250(a) were 100 percent, over the excess of the amount described in section 1(h)(4)(B) over the amount described in section 1(h)(4)(A). Section 1(h)(1)(E) subjects that amount to a 25 percent rate, and section 1(h)(3)(A)(i) removes it from adjusted net capital gain so that it does not also get the lower rates.

Two limits keep it from running away. Section 1(h)(6)(B) provides that the amount from sales, exchanges and conversions described in section 1231(a)(3)(A) for a taxable year cannot exceed the net section 1231 gain for that year. And the definition itself excludes gain otherwise treated as ordinary income, so the same depreciation is not counted twice. Publication 544 summarizes both points and directs the computation to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

The 2025 change most issue maps do not have yet

Public Law 119-21 added section 168(n), an elective 100 percent allowance for qualified production property, which is a designated portion of nonresidential real property used as an integral part of a qualified production activity, constructed beginning after January 19, 2025 and before January 1, 2029, and placed in service before January 1, 2031. It also added subparagraph (G) to section 1245(a)(3), so that qualified production property as defined in section 168(n)(2) is section 1245 property; the Amendments note on the section 1245 page records the addition by Public Law 119-21, section 70307(b). The Effective Date of 2025 Amendment note on that same page states that the amendment applies to property placed in service after July 4, 2025, cross-referencing section 70307(c) as set out under section 168.

The consequence for a disposition map is direct: a portion of a building can now be section 1245 property, with full ordinary recapture of the allowance on sale, rather than section 1250 property generating unrecaptured section 1250 gain at 25 percent. Publication 946 for 2025 also notes a use-based recapture that can be triggered without any disposition at all. Any building placed in service after July 4, 2025 should be checked for a section 168(n) election before its gain is characterized.

Scope, siblings, and the next step

This page maps character and order. It does not compute gain, allocate a purchase price among assets, or address deferral. Where a disposition is structured as an exchange rather than a sale, the sibling page Section 1031 after the real property limit: eligibility and timing checklist covers the deferral conditions, and notes that recapture can be triggered by boot even inside a qualifying exchange. Where the classification of building components is the live issue, Cost segregation studies: what the IRS audit guide expects you to support covers the evidence that supports it.

A workable next step is to list each asset disposed of, its original cost, every depreciation and expensing adjustment reflected in basis, and the amount realized allocated to it, then walk the six steps above in order. Ask Taxterity a research question about the ordering on your facts, or have it prepare a Federal Tax Memo on the character of the gain, and then verify each section cited against the statute before the return position is set.

Related research

Official sources

  1. 26 U.S.C. § 1245 — Gain from dispositions of certain depreciable property — § 1245(a)(1); (a)(2)(A)-(C) recomputed basis and deductions treated as amortization; (a)(3)(A)-(G) definition, including (G); (b)(3), (b)(4); Amendments 2025 note (Pub. L. 119-21 § 70307(b)) and Effective Date of 2025 Amendment note
  2. 26 U.S.C. § 1250 — Gain from dispositions of certain depreciable realty — § 1250(a)(1)(A) general rule and recognition override; (a)(1)(B)(v) applicable percentage of 100 percent for all other section 1250 property; (b)(1) additional depreciation defined by reference to the straight line method; (c) definition
  3. 26 U.S.C. § 1231 — Property used in the trade or business and involuntary conversions — § 1231(a)(1)-(a)(3) netting and definitions; (a)(4)(C) separate casualty and theft netting; (b)(1) property used in the trade or business; (c)(1)-(c)(4) recapture of net ordinary losses over the five most recent preceding taxable years
  4. 26 U.S.C. § 1 — Tax imposed — § 1(h)(1)(E) 25 percent rate; (h)(3)(A)(i) exclusion from adjusted net capital gain; (h)(6)(A) definition of unrecaptured section 1250 gain; (h)(6)(B) limitation to net section 1231 gain; (h)(8) allocation of section 1231(c) amounts
  5. 26 U.S.C. § 168 — Accelerated cost recovery system — § 168(n)(1) and (n)(2)(A), elective 100 percent allowance for qualified production property; Effective Date of 2025 Amendment note, Pub. L. 119-21 § 70307(c), property placed in service after July 4, 2025
  6. IRS Publication 544 (2025), Sales and Other Dispositions of Assets — Chapter 3, Section 1231 Gains and Losses, headings Treatment as ordinary or capital and Nonrecaptured section 1231 losses; and Depreciation Recapture, headings Section 1245 Property, Section 1250 Property, and Applicable Percentage
  7. IRS Publication 544 (2025), Sales and Other Dispositions of Assets — Chapter 4, heading Unrecaptured section 1250 gain, including the limitation to net section 1231 gain and the reference to the Unrecaptured Section 1250 Gain Worksheet in the Instructions for Schedule D (Form 1040)
  8. IRS Publication 946 (2025), How To Depreciate Property — Chapter 3, heading Qualified Production Property, including the note on ceasing to use the property as an integral part of a qualified production activity within 10 calendar years of placing it in service

Limitations