Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What is an Unrecaptured Section 1250 Gain?
An Internal Revenue Service (IRS) tax provision recaptures the previously recognized depreciation into income when a gain is realized on the sale of depreciable real estate property this is called unrecaptured section 1250 gain.
As of 2019, the unrecaptured section 1250 gains are taxed with a higher limit of 25% tax rate, or less in some cases.
Within Schedule D instructions, the unrecaptured section 1250 gains are calculated on a worksheet and after they are reported on the Schedule D they are carried through to the taxpayer’s 1040.
The working of unrecaptured section 1250 gains
All depreciable capital assets owned by a taxpayer for longer than one year are Section 1231 assets. All the assets belonging to section 1245 and section 1250, have the umbrella of Section 1231 and the tax rate of depreciation recapture is determined by Section 1250.
Section 1250 associates only to real property, like the buildings and land. Under section 1245 the personal property, like machinery and equipment, is subject to depreciation recapture as ordinary income.
When there is a net Section 1231 gain only then the unrecaptured section 1250 gains are realized.
As the capital losses on all depreciable assets counterbalance unrecaptured section 1250 gains on real estate, the unrecaptured section 1250 gain is reduced to zero by a net capital overall loss.
Upon the sale of depreciated real estate the section 1250 gain is recaptured, similar to any other asset; with the only difference in the rate of it being taxed. The reason for the gain is to neutralize the benefit of previously used depreciation allowances.
While the gains assigned to collected depreciation are taxed at the section 1250 recapture tax rate, the balance gains are only subject to the long-term capital gains rate of 15%.
Example of unrecaptured section 1250 gains
If a property was initially purchased for $ 200,000, and the owner claims depreciation of $ 30,000, the adjusted cost basis for the property is considered to be $170,000.
If the property is subsequently sold for $225,000, the owner has recognized an overall gain of $55,000 over the adjusted cost basis.
Since the property has sold for more than the basis that had been adjusted for depreciation, the unrecaptured section 1250 gains are established on the difference between the adjusted cost basis and the original purchase price.
Making the first $30,000 of the profit liable to the unrecaptured section 1250 gain, while the remaining $25,000 is taxed at the regular long-term capital gains.
So the higher capital gains tax rate of up to 25% would be applicable on $30,000. The remaining $25,000 would be taxed at the long-term capital gains rate of 15%.
Special Considerations
The unrecaptured section 1250 gains can be offset by capital losses as they are looked at as a form of capital gains.
For this, through Form 8949 and Schedule D the capital losses must be reported, and the value of the loss could depend on whether it is determined to be short-term or long-term in nature.
This determination of it to be short-term or long-term will help a capital loss to offset a capital gain. Because a short-term loss can only offset a short-term gain and a long-term loss can offset a long-term gain and not vice versa.
Conclusion
An unrecaptured section 1250 gain relevant only on the sale of depreciable real estate. The depreciation recapture can be avoided on a rental property by using a 1031 exchange, which allows investors to defer most of their recapture taxes (not the capital gain tax)
These are usually taxed at a maximal rate of 25%. The section 1250 gains can be equalized by 1231 capital losses.
