44.2 Depreciation Recaptured as Ordinary Income on Sale of Real Estate

All or part of gain on the sale of depreciable real property may be attributable to depreciation deductions that reduced the basis of the property. On Form 4797, gain attributable to depreciation on Section 1250 realty placed in service before 1987 is subject to recapture as ordinary income unless straight-line depreciation was used. The amount of depreciation recapture depends on when the building was placed in service and whether it was residential or nonresidential; see below.

There is no ordinary income recapture for residential rental and nonresidential real property placed in service after 1986 because such properties are depreciated using the straight-line MACRS method (42.13). However, the 30% or 50% bonus depreciation that had been allowed on qualifying New York Liberty Zone real property and 50% bonus depreciation on GO Zone property is subject to recapture on Form 4797. Similarly, 50% bonus depreciation claimed for qualifying property placed in service after December 31, 2007, and before September 9, 2010, or 100% bonus depreciation for property placed in service after September 8, 2010, and before January 1, 2012, or 50% bonus depreciation for property placed in service after December 31, 2011, and before January 1, 2013 (42.20), will be subject to recapture.

To the extent depreciation is not subject to ordinary income recapture, the gain on the sale is subject to the Section 1231 netting rules (44.8). If there is a net Section 1231 gain, the gain attributed to the depreciation is entered on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D (Form 1040) instructions. The unrecaptured Section 1250 gain from that worksheet is subject to a top rate of 25% on the Schedule D Tax Worksheet included in the Schedule D instructions.

Recaptured depreciation.

Ordinary income recapture may apply to Section 1250 realty placed in service before 1987. Section 1250 property includes buildings and structural components, except for elevators and escalators or other tangible property used as an integral part of manufacturing, production, or extraction, or of furnishing transportation, electrical energy, water, gas, sewage disposal services, or communications. Property may initially be Section 1250 property and then, on a change of use, become Section 1245 property (44.1). Such property may not be reconverted to Section 1250 property.

Depreciation claimed on realty placed in service after 1980 and before 1987.

For real property placed in service after 1980 and before 1987 that was subject to ACRS, adjusted basis for computing gain or loss is the adjusted basis at the start of the year reduced by the ACRS deduction allowed for the number of months the realty is in service in the year of disposition (42.15). The recapture rules distinguish between residential and nonresidential property.

If the prescribed accelerated method is used to recover the cost of nonresidential property, all gain on the disposition of the realty is recaptured as ordinary income to the extent of recovery allowances previously taken. Thus, nonresidential realty will be treated in the same way as personal property (44.1) for purposes of recapture if the accelerated recovery allowance was claimed. If the straight-line method was elected, there is no recapture; all gain is subject to the netting rules of Section 1231 (44.8).

If accelerated cost recovery is used for a nonresidential building and straight-line depreciation is used for a substantial improvement to that building that you are allowed to depreciate separately (42.15), all gain on a disposition of the entire building is treated as ordinary income to the extent of the accelerated cost recovery claimed. Remaining gain is subject to the rules for Section 1231 assets (44.8).

For residential real estate, 100% of the excess depreciation claimed is subject to recapture. That is, there is ordinary income recapture to the extent the depreciation allowed under the prescribed accelerated method exceeds the recovery that would have been allowable if the straight-line method over the ACRS recovery period had been used. If the straight-line method was elected, there is no recapture. All gain is subject to Section 1231 netting (44.8).

For low-income rental housing, the percentage of excess depreciation (over straight-line) subject to recapture is 100% minus 1% for each full month the property was held over 100 months, so that there is no recapture of cost recovery deductions for property held at least 200 months (16 years and 8 months). If you dispose of low-income housing with separate improvements, or with units placed in service at different times, the amount of excess depreciation must be computed separately for each element. See IRS Publication 544 for details on the recapture rules for low-income housing.

Different recapture rules applied to depreciation on realty placed in service before 1981.