Understanding the 25% maximum tax rate on gains from selling Section 1250 real property.

Outline:

• Hook: Real estate gains come with different tax twists, and the 25% cap on unrecaptured Section 1250 gains often surprises people.

• What is Section 1250 real property? Quick definition and why it matters.

• Depreciation recapture explained: what gets taxed, and at what rate.

• The 25% maximum: how it applies to unrecaptured 1250 gain.

• A clear example with numbers to illustrate the concept.

• How this fits with regular long-term capital gains.

• Practical takeaways for real estate owners and investors.

• Quick FAQs to clear up common questions.

Understanding the 25% cap on unrecaptured Section 1250 gain

Let me explain a tax nuance that comes up whenever real estate is part of your financial picture. When you own and then sell real property that’s Section 1250 property—think real estate with improvements like office buildings—the IRS keeps a close eye on how much depreciation you’ve claimed over the years. The result is a special tax treatment called unrecaptured Section 1250 gain. And yes, there’s a specific maximum rate tied to that gain: 25%. That’s the part of your gain that’s linked to depreciation deductions you previously took, and the tax rate isn’t the same as your regular capital gains rate for the rest of the gain.

What exactly is Section 1250 real property?

Section 1250 property refers to real estate that has been improved with an economic life that allows depreciation. Commercial buildings, rental properties, and other real estate assets fall into this bucket. If you’ve claimed depreciation on these assets during ownership, the IRS wants to “recapture” some of that benefit when you sell. In practice, that means a portion of your gain is taxed differently from other asset classes.

Depreciation recapture: how it works

Here’s the heart of the matter. When you sell a Section 1250 property, the portion of your gain that corresponds to depreciation deductions is treated as “unrecaptured Section 1250 gain.” This portion is subject to a maximum tax rate of 25%. The idea is simple: you got a tax break through depreciation while you owned the property, so part of the gain on sale is taxed at a higher rate than the rest of your capital gains to recover some of that benefit.

To keep this straight: not all of your gain is taxed at 25%. Only the portion equal to depreciation deductions you claimed over the years. The remaining gain is eligible for the regular long-term capital gains rates (0%, 15%, or 20%, depending on your income and filing status). So you end up with a split:

• Depreciation-related portion (unrecaptured Section 1250 gain) taxed at up to 25%.

• The rest taxed at capital gains rates, which can be lower or higher depending on your situation.

Why 25%? It’s all about balancing depreciation benefits with future tax liability

Depreciation is a powerful incentive to invest in real estate. It lowers taxable income during the holding period. But when you sell, the IRS wants to “recapitalize” some of those benefits to maintain revenue flow. The 25% cap on the unrecaptured 1250 gain is the IRS’s way of capturing a fair share of the depreciation you claimed. It’s a compromise that protects the tax system from the unintended windfall of heavy depreciation upfront while still letting the rest of your gain ride on the long-term capital gains framework.

A practical example to bring it to life

Let’s walk through a simple scenario so the numbers speak clearly. Suppose you buy a commercial building for $500,000. Over the years, you claim $120,000 in depreciation. Your adjusted basis at sale is $380,000 (that’s the original cost minus depreciation). You sell the property for $640,000.

• Total gain on sale: $640,000 sale price minus $380,000 adjusted basis = $260,000.

• Portion of gain attributable to depreciation (the unrecaptured 1250 gain): $120,000.

• Tax on the unrecaptured 1250 gain: $120,000 × 25% = $30,000.

• Remaining gain: $260,000 − $120,000 = $140,000. This portion is taxed at the long-term capital gains rate (0%, 15%, or 20% depending on your overall income and filing status).

In short, you’d owe $30,000 on the depreciation portion, plus whatever the applicable capital gains rate would be on the rest. The exact total depends on your other income and tax bracket, but the key takeaway is the 25% ceiling on the depreciation-driven portion.

How this interacts with regular capital gains

Think of your total gain as a two-part story. Part one is the depreciation you claimed—this is the unrecaptured 1250 gain, capped at 25%. Part two is everything else that isn’t tied to depreciation. That portion follows the more familiar long-term capital gains rates, which are typically lower than ordinary income tax rates. If you’re in a higher income bracket, the cap still caps the first portion at 25%, while the remaining gain may still benefit from the lower capital gains rates.

This isn’t just a theoretical distinction. It affects how you plan transformations to your real estate portfolio. If you know you’ll realize large gains, you might think through strategies that manage depreciation deductions in prior years or consider timing the sale to align with lower income years. It’s not about gaming the system; it’s about understanding how the pieces fit so you can make informed, practical decisions.

What this means for real estate owners and investors

• Depreciation matters beyond the holding period. The deductions you took in earlier years show up again at sale as part of the gain.

• The 25% cap is specific to the depreciation-driven portion, not the entire gain.

• The rest of your gain follows long-term capital gains rules, so your overall tax picture can be a mix of rates.

• Planning helps. If you have a sizable depreciation history, you’ll want to factor that into sale timing and potential tax planning moves.

A few takeaways to keep handy

• Always separate the gain into two buckets: depreciation-driven (unrecaptured 1250 gain) and the rest.

• The depreciation-driven bucket never exceeds 25% at the federal level.

• The other portion of the gain will be taxed at long-term capital gains rates, which are generally favorable but depend on income.

• When you’re weighing a sale, run the numbers both ways—what the depreciation looks like if you’d sold earlier versus later, and how that affects your tax outcome.

Common questions that pop up (short answers)

• Is the 25% rate the same for all property types? It’s specific to Section 1250 real property. Other types of property have different rules for depreciation recapture, so the 25% cap doesn’t automatically apply there.

• Do state taxes change this? States have their own tax rules, so you could see additional state-level taxes on top of the federal treatment.

• Can I avoid the 25% by doing something else? The 25% cap is about the depreciation you claimed; planning around sale timing and overall tax strategy can influence the total tax burden, but the 25% rate on the depreciation portion is a built-in rule.

• What if I didn’t take much depreciation? If you didn’t claim much depreciation, there isn’t much to recapture, so your depreciation-driven gain would be smaller or zero, and more of your gain would be in the regular capital gains bucket.

Wrapping up with a clear picture

Real estate brings both opportunity and complexity to the tax picture. The maximum 25% rate on the unrecaptured Section 1250 gain is a key piece of that puzzle. It acknowledges the depreciation benefits you enjoyed while you owned the property, while still aligning with the long-term capital gains framework for the rest of the gain. For anyone who owns or plans to own real property, understanding this rule helps you forecast tax outcomes with greater clarity and make smarter, more informed decisions about your real estate portfolio.

If you’re navigating real estate and taxes, you’ll likely encounter more rules that shape the bottom line. The more you know about how depreciation interacts with sale gains, the more confident you’ll feel when the time comes to make a move. And yes, while numbers can look intimidating at first glance, breaking them down into bite-sized steps makes the path much clearer. After all, real estate is not just about buildings and leases—it’s about what you can do with the numbers to build a solid, future-ready plan.