Depreciation Recapture — Sections 1245 and 1250 (Portfolio 563)


Victoria Kelly

Tax Management Portfolio Authors

At a glance

I. Purpose and General Application of §1245 and 1250
II. Property Subject to Recapture
III. Dispositions That Trigger §1245 and 1250
IV. Amount Subject to Recapture
V. Multiple Classes, Items, or Elements of Property
VI. Methods of Accounting
VII. Special Effects of §1245 and 1250
VIII. Tax Planning

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Tax Management Portfolio, Depreciation Recapture — Sections 1245 and 1250, No. 563, explains the purpose of §1245 and 1250, and describes the types of property subject to depreciation recapture.

Sections 1245 and 1250 were enacted to close the loophole that resulted from allowing depreciation deductions on assets to offset ordinary income while taxing gain from the sale of these depreciated assets as capital gains. Sections 1245 and 1250 close the loophole by recharacterizing part or all of the gain on transfers of depreciable assets as ordinary income.

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Sections 1245 and 1250 generally apply to any transfer of depreciable property (including certain property that is expensed under rules similar to depreciation rules, such as rapid amortization property and property that has been expensed under §179). Certain transfers of depreciable property, however, are excepted from depreciation recapture.

The gain treated as ordinary income by §1245 is the amount by which the lower of the property's (1) amount realized or fair market value (depending on the type of disposition), or (2) recomputed basis (i.e., the property's basis plus all amounts allowed for depreciation) exceeds the property's adjusted basis. The gain treated as ordinary income by §1250 is the applicable percentage (generally 100%) of the lower of (1) the portion of depreciation that exceeds what would have been permitted under the straight-line method, or (2) the excess of the amount realized (or fair market value, depending on the type of disposition) over the property's adjusted basis.

This Portfolio emphasizes tax planning and discusses means for reducing the impact of §1245 and 1250, including such strategies as the careful timing of dispositions, and the use of certain accounting methods. Sections 1245 and 1250 have an impact on taxpayers that is more significant than just the rate differential between capital gains and ordinary income. For instance, characterizing gain as ordinary rather than capital could affect a taxpayer's capital loss deduction, as well as the reporting of gain from installment sales.

Opportunity Zones Proposed Regulations Roadmap

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