When commercial real estate or a rental property is sold at a profit, taxes have to be paid on the gain. The tax rate for that gain is different for an unrecaptured Section 1250 gain than it is for the typical long-term capital gain rate that is based on your regular tax bracket.
Unrecaptured Section 1250 gain is the portion of a capital gain related to the amount a property has already been depreciated. Any portion of the sale price of real estate that was previously depreciated is subject to a higher capital gain rate, which is usually 25%. Unrecaptured Section 1250 gain only applies to depreciable real estate, such as commercial real estate and residential rental properties.
For example, if an investor purchases an income property for $200,000 and has claimed $50,000 for depreciation deductions, the adjusted cost basis is now $150,000. If the investor then sells that property for $250,000, there is a total capital gain of $100,000 over the adjusted basis. The $50,000 of that gain that is a result of the depreciation that has been claimed on the property is the unrecaptured Section 1250 gain. The Internal Revenue Service (IRS) requires the unrecaptured gain to be recaptured and taxed at the 25% capital gains tax rate, while the other $50,000 that was a gain over the original purchase price is taxed at the normal long-term capital gain rates. This simplified example is demonstrated in the table below.