The IRS taxes depreciation recapture differently depending on asset type. Section 1245 property recaptures all depreciation as ordinary income, while 1250 property (real estate) recaptures only excess depreciation above straight-line at ordinary rates, with straight-line gains taxed at 25% max. Rental investors using bonus depreciation or cost segregation should plan for recapture if selling soon.
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Okay. Depreciation recapture. Okay. So depreciation is when you have a fixed asset and you're expensing a portion of that over the time that you're using it in your business. Now, the IRS looks at property in buckets, right? So you have 1231 property, and that is property that is used in a trade or business. It's something that you're holding for longer than 12 months and is subject to depreciation under Section 167. Then that is broken out into 2 other buckets, 1245 property and 1250 property. 1245 property is personal tangible property, 5 and 7-year type assets. 1250 is for real estate, real property, and land improvements. So what that means is when you have, when you have an asset that you've been depreciating and then you sell that asset down the road, the IRS says, look, we gave you a deduction for that depreciation against your ordinary income in a prior year. If you're going to sell it, For a gain, we're going to recapture that back at ordinary income rates. So that's where this whole recapture thing comes from. So 1245 property says that however much you depreciated, however you depreciate straight line, bonus, whatever, we're pulling all that back as recaptured depreciation at ordinary income rates. 15-year 1250 property land improvements, those are similar but different in the sense that the The IRS says, look, we're going to make you recapture a piece of that depreciation, but only the amount over straight line is going to be taxed at ordinary income rates. So if you took accelerated depreciation over a 15-year asset, you're going to have to calculate what that straight line would've been. And then whatever the difference was between what you took in the accelerated way is then pulled back into as depreciation recapture. Then you have— Unrecaptured 1250 gain, and that is for 27.5-year and 39-year assets. And that essentially is whatever you took for depreciation for that building, which was on straight line. That portion is going to be taxed at a maximum rate of 25%. So that means if you're in a 37% tax bracket, 25% is much better, right? Because that's the max. You're not going to get hit with 37. You get hit with 25 on that. If you're in a 12% bracket, you're only going to pay— you're going to get that 12% on that amount. And that's the building depreciation, right? So these are important things to realize because if you are going to do something with a rental property like cost seg, bonus depreciation, you want to take into consideration if you're going to sell it in a year or 2, you're going to have to recapture all this depreciation back anyway. So it's just something to kind of bring up with your tax advisor to say, hey, does this make sense? If I'm going to do this, should I do this, right? So again, this is educational, a lot of nuance to this one. We're going to do a long-form video with slides and examples and all that kind of stuff. I hope this helps. If you have questions, please hit me up. This is a big one. Talk soon.
