Depreciation Recapture

Depreciation recapture is the rule that claws back prior depreciation deductions when an asset is sold at a gain. For personal property like equipment and vehicles (Section 1245 property), gain up to the total depreciation taken is taxed as ordinary income rather than capital gain; only gain above the original cost is capital gain. For real estate (Section 1250 property), straight-line depreciation is not recaptured as ordinary income, but the gain attributable to it, called unrecaptured Section 1250 gain, is taxed at a maximum 25% rate instead of the usual capital gains rates. Recapture is why accelerated deductions are a deferral, not a permanent exclusion: the benefit is the time value of money plus any rate arbitrage. Strategies that manage recapture include 1031 exchanges (which defer it), holding until death (basis step-up erases it), and installment sales (which do not defer 1245 recapture).