A ceiling, not a rate
Below 25 percent you pay your ordinary rate on the gain created by depreciating the building.
The short answer
1245 has no ceiling
Appliances and removable carpet are Section 1245 property. Gain up to the depreciation you took on them is ordinary income, with no ceiling at all.
New York stacks on top
25 percent is a federal number. Net investment income tax, state tax and city tax apply on top.
Have us model your recapture before you list
Send us the closing statement and the depreciation schedule and we will tell you what the sale costs before you sign anything. Call (212) 641-0673 or use the contact form. We come back within 24 hours, and we are available evenings and weekends. Confidential, and handled by a CPA or EA, not a call center.
Where the number lives
Right for one slice, wrong for the rest
Sell a rental building and the first number that comes up is 25 percent. It is the right number for one slice of the gain and the wrong number for the rest of it, which is why the estimate and the bill differ.
The depreciation recapture rate of 25 percent is a ceiling. It caps the federal tax on the part of your gain that exists because you claimed depreciation on the building. It caps nothing else, and in New York it is not the last layer of tax you pay.
01What counts
What counts as unrecaptured Section 1250 gain
One slice of your gain, and only one: the long term gain that exists because you depreciated Section 1250 property. That is the building, its structural components, and any land improvement that is not Section 1245 property.
Three steps produce the figure.
- Start with the lower of your gain or the depreciation you could have claimed, taken or not.
- Subtract anything already recaptured as ordinary income.
- What is left is unrecaptured Section 1250 gain, taxed at a maximum rate of 25 percent.
The slice is taxed at your ordinary rate, and the ceiling only applies once your ordinary rate exceeds 25 percent.
25%
ceiling on unrecaptured Section 1250 gain
0/15/20%
on gain above your depreciation
Up to 37%
on Section 1245 depreciation — no ceiling
3.8%
net investment income tax may apply above $200K single or $250K joint
02Outside the ceiling
What falls outside the 25 percent ceiling
Three things, and each is taxed better or worse than 25 percent rather than at it.
- Gain above your depreciation. Held more than a year, what is left after the recapture rules is Section 1231 gain. Net it against your other Section 1231 items and the remainder is long term capital gain at 0, 15 or 20 percent. The five year lookback can turn part of it ordinary first.
- Section 1245 property. Appliances, removable carpet and equipment specific wiring and plumbing. Section 1245 recapture takes gain up to the depreciation you could have claimed on those items. It is ordinary income at your marginal rate, up to 37 percent, with no 25 percent ceiling.
- Additional depreciation on the building. Depreciation taken faster than straight line comes back as ordinary income. Residential and commercial buildings both run straight line, so the building itself rarely produces any. Bonus depreciation on qualified improvement property does, and so does declining balance on 15 year land improvements that are Section 1250.
03Worked example
A $430,000 gain split into three rate buckets
You buy a Brooklyn rental in 2015 for $600,000, of which $150,000 is land. You claim $180,000 of straight line depreciation on the building. You sell in 2026 for $850,000.
- Adjusted basis: $600,000 less $180,000 depreciation, so $420,000.
- Total gain: $430,000.
- $180,000 is unrecaptured Section 1250 gain, capped at 25 percent, so up to $45,000 of federal income tax, before net investment income tax.
- $250,000 is Section 1231 gain, generally long term capital gain at 0, 15 or 20 percent after netting.
Now change one fact. Say a cost segregation study had moved $110,000 onto Section 1245 assets such as appliances and removable carpet. Where the sale allocates at least $110,000 of gain to those assets, that $110,000 is ordinary income at up to 37 percent. The 1250 slice falls to $70,000 and the $250,000 is unchanged.
A $430,000 gain split into three rate buckets
Bought $600,000 in 2015, sold $850,000 in 2026, $180,000 depreciation, cost segregation study moved $110,000 onto Section 1245 assets.
$110,000
Section 1245 property, appliances and carpet
Ordinary rates, up to 37 percent. No ceiling.
$70,000
Unrecaptured Section 1250 gain, the building
Ceiling of 25 percent, so up to $17,500.
$250,000
Section 1231 gain
0, 15 or 20 percent.
Bar widths are proportional to the dollars. $110,000 + $70,000 + $250,000 = $430,000. Without a cost segregation study all $180,000 of the depreciation is unrecaptured Section 1250 gain. Illustrative example, not tax advice.
04What people get wrong
Why 25 percent is a ceiling and not your rate
The belief
My gain is taxed at 25 percent.
What is true
Only long term gain created by depreciating Section 1250 property can reach that ceiling, never more than the depreciation itself. In the sale above, that is $180,000 out of a $430,000 gain. The rest is capital gain, taxed on a different scale.
Why it costs money. Owners who assume one flat 25 percent set aside the wrong amount and price the deal on the wrong net. A cost segregation study moves part of the building into Section 1245, where there is no ceiling. That is an argument for modeling the exit, not for skipping the study.
05Cost segregation at the exit
What a cost segregation study costs you at the exit
A cost segregation study moves part of the building into Section 1245, where no 25 percent ceiling applies. You take the deduction early at your ordinary rate, and the tax comes back at your ordinary rate.
Move $110,000 of a building into Section 1245 and the federal tax on that slice rises from 25 percent to your ordinary rate. At the top rate that is a 12 point difference, or $13,200 of extra federal tax at the exit. What that buys is the deduction years earlier.
Cost segregation study: deduction timing against exit cost
| No study | With a study | |
|---|---|---|
| When you get the deduction | About $4,000 a year, 2015 to 2042 | All $110,000 in 2015 — worth $40,700 saved that year |
| What that slice costs at sale (March 2026) | $27,500 (capped at 25%) | $40,700 (ordinary rates) |
| Difference at exit | $13,200 more |
Eleven years of use of $40,700, against $13,200 more tax in 2026. Illustrative, your own figures will differ.
A study tends to lose money where:
- You expect a taxable sale within two or three years and an exchange is unlikely.
- Your bracket is lower now than it will be in the year of the sale.
- The deductions would remain suspended passive losses you cannot use, while the recapture builds anyway.
A study tends to pay where you hold for a long period, where you exchange rather than sell, or where you can use the losses in the year you take them.
The allocation in your sale contract can shrink the ordinary rate slice. Section 1245 recapture stops at the actual gain on each asset, and ten year old appliances and carpet rarely sell for anything near cost. Make the allocation defensible, and settle it before you sign.
06What New York adds
What a New York seller pays on top
Three more layers apply: net investment income tax, New York State tax and New York City tax.
- Net investment income tax may apply at 3.8 percent once modified adjusted gross income clears $200,000 for a single filer or $250,000 filing jointly. It reaches the lesser of your net investment income or the amount by which you cleared. Where it applies, the real federal ceiling is 28.8 percent rather than 25.
- New York State. The state gives capital gains no preferential rate, so the gain is taxed as ordinary income on the regular brackets, which reach 10.9 percent for 2026.
- New York City. City resident income tax reaches 3.876 percent for 2026, on the same gain, if you live in one of the five boroughs.
Stacked at the top of every one of those scales, a New York City resident faces a marginal rate a little under 44 percent on the recaptured slice. Sellers further down the brackets are well below that. Plan around your own combined rate, not 25 percent.
Tax layers on the capped slice for a New York City seller
$70,000 capped slice, Brooklyn resident, at the top of every scale
| Layer | Rate | Tax |
|---|---|---|
| Federal ceiling | 25.000% | $17,500 |
| Net investment income tax | 3.800% | $2,660 |
| New York State | 10.900% | $7,630 |
| New York City | 3.876% | $2,713 |
| Combined | 43.576% | $30,503 |
Most sellers are below the top of these scales and pay less. Illustrative example, not tax advice.
07Forms
Form 4797 and Schedule D line 19
Where the number flows
Form 4797 · Part III
Ordinary recapture under Sections 1245 and 1250 is computed here.
→
Form 4797 · Part II
Ordinary recapture carries here, then on to your 1040.
→
Schedule D · line 19
What is left runs through the Unrecaptured Section 1250 Gain Worksheet and is recorded here.
Schedule K-1 · box 9c
For partnership and LLC owners
Box 9c of Schedule K-1 carries your share of the entity’s unrecaptured Section 1250 gain — you may never see a Form 4797. That figure runs to the worksheet on your own return.
Box 9c can hold more than one thing
Origin 1
The entity selling Section 1250 property.
Origin 2
The entity selling an interest in another partnership.
Origin 3
An estate, trust, REIT or RIC further up the chain.
If your K-1 shows an attached statement rather than one figure, that is why. Selling your own interest in the partnership is separate again, and goes on line 10.
08Installment sales
Installment sale depreciation recapture splits in two
Installment sale depreciation recapture does not behave as one thing. The two halves are taxed on different timetables.
- Recapture income under Sections 1245 and 1250 is ordinary income, taxed in full in the year of sale under Section 453(i). That holds even if the only cash you saw was the deposit.
- Unrecaptured Section 1250 gain is not recapture income for that rule, so it spreads across the payments and comes out first in each year’s gain.
The capped slice comes out of the front of that spread, not evenly, so early years carry more tax than the cash suggests. The ordinary recapture is taxed in year one and added back to your basis, so it is not taxed twice. What is left spreads on one ratio, fixed for the life of the note.
A seller financed deal on a heavily cost segregated building can therefore produce a year one tax bill larger than the year one cash.
The example below takes the same Brooklyn sale over five annual payments of $170,000 and shows which year each slice falls in.
Which year each slice of the $430,000 gain is recognized in
| Year | Ordinary | Capped slice | Capital gain |
|---|---|---|---|
| 2026 | $110,000 | $64,000 | — |
| 2027 | — | $6,000 | $58,000 |
| 2028 | — | — | $64,000 |
| 2029 | — | — | $64,000 |
| 2030 | — | — | $64,000 |
| Total | $110,000 | $70,000 | $250,000 |
Sold March 1, 2026 on five annual payments of $170,000. Ordinary recapture in full in year one. Capped slice comes out first as payments arrive. Illustrative.
09FAQ
Unrecaptured Section 1250 gain questions
Is depreciation recapture taxed at 25 percent?
No. 25 percent is a ceiling on one slice of the gain, the unrecaptured Section 1250 gain created by depreciating the building. Section 1245 property carries no ceiling, and gain above your depreciation is long term capital gain.
What is the highest combined rate a New York City seller pays on the capped slice?
A little under 44 percent, and only at the top of every scale. That figure stacks the 25 percent federal ceiling, 3.8 percent net investment income tax, 10.9 percent state tax and 3.876 percent city tax. Most sellers land far lower, and the only number worth planning around is your own.
Which parts of a building are Section 1245 property?
The removable and equipment specific items: appliances, removable carpet, and wiring and plumbing serving a business process rather than the building. Permanently affixed flooring is Section 1250 property. Fencing, parking and landscaping fall either side depending on which they serve.
Does the net investment income tax apply to depreciation recapture?
It can. Two thresholds control it, $200,000 for a single filer and $250,000 filing jointly, both measured on modified adjusted gross income. Crossing one does not pull your whole gain in. The tax reaches the lesser of your net investment income or the amount by which you cleared.
Where does unrecaptured Section 1250 gain appear on my return?
On line 19 of Schedule D, after the Unrecaptured Section 1250 Gain Worksheet. Owners of a partnership or an LLC taxed as one receive their share in box 9c of Schedule K-1 instead.
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From the record
On planning six or nine months ahead
“Make sure to start planning with a professional far ahead of time, maybe six months before, nine months before.”
George Dimov, CPA
“I worked with the Dimov team for my incredibly complicated 2024 taxes (w2, self employment and rental income), and they did a superb job. The process was incredibly straightforward, and they kept me up to date throughout.”
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Reviewed by George Dimov, CPA, New York, NY. Serving clients in all 50 states, 15+ years advising property owners on basis, depreciation and sale timing. President of George Dimov, CPA, a New York City firm serving clients across the five boroughs and nationwide.