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Unrecaptured Section 1250 Gain: Definition – Explanation – Example

What Is an Unrecaptured Section 1250 Gain?

Unrecaptured Section 1250 GainAn unrecaptured Section 1250 gain occurs when selling real estate for financial gain after claiming depreciation tax breaks in previous years. Section 1250 is part of the Internal Revenue Service (IRS) tax code.  It allows previously recognized depreciation to be reclaimed as income.  This happens when you realize a gain on the sale of depreciable real estate property. Specifically, the profit you get after selling a Section 1231 asset for which you previously claimed depreciation tax. As of 2019, unrecaptured section 1250 gains are taxed at a maximum of 25%, or less in some situations. Section 1250 only applies to real properties, such as buildings and land. Unrecaptured section 1250 gains are calculated on a worksheet included with the Schedule D instructions.  These are reported on Schedule D and carried through to the taxpayer’s 1040.

The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate. If your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 16 of Schedule D (Form 1040). Claim the loss on line 7 of your Form 1040 or Form 1040-SR. If your net capital loss is more than this limit, you can carry the loss forward to later years. You may use the Capital Loss Carryover Worksheet found in Publication 550, Investment Income and Expenses or in the Instructions for Schedule D (Form 1040)PDF to figure the amount you can carry forward.(Source: irs.gov)

Unrecaptured Section 1250 Gain – A Closer Look

Section 1250 classifies a gain from selling property as “unrecaptured” if the sales price exceeds the initial cost basis.  This is the sum of what you paid for it and what you spent on maintenance. It changes this base by adding back the reported depreciation. An unrecaptured Section 1250 gain basically prevents you from benefiting from a twofold tax advantage. It alters the rate at which realized profits are taxed in order to balance the depreciation you claimed. It prevents you from claiming favorable long-term capital gains rates on the entire amount of your profit.

However, the Internal Revenue Code allows taxpayers to offset losses against gains. In this case, the IRS permits you to balance Section 1250 gains with Section 1231 capital losses.  But, both assets must have been kept for more than a year so both the loss and gain are long-term. As a result, you can deduct your loss from your gain and pay tax on the difference. A section 1250 gain is recaptured when depreciated real estate is sold, just like any other asset. However, the only difference is the tax rate. The gain is justified by the need to offset the benefit of previously utilized depreciation allowances. While gains linked to accumulated depreciation are taxed at the Section 1250 recapture tax rate.  But, any leftover gains are only taxed at the long-term capital gains rate of 15%.

Section 1231

Section 1231 covers long-term, depreciable capital assets held by a taxpayer for longer than one year. This part of the IRS tax code serves as a catch-all for assets covered by sections 1245 and 1250.  The latter of which determines the tax rate on depreciation recapture. Section 1250 only applies to real properties such as buildings and land. Personal property, such as machinery and equipment, is subject to section 1245 depreciation recapture as ordinary income. Only when there is a net Section 1231 gain are unrecaptured Section 1250 gains realized. Capital losses on all depreciable assets effectively counterbalance unrecaptured section 1250 gains on real estate. As a result, a net capital loss decreases the section 1250 gain to zero.

Short-Term or Long-Term

Capital gains and losses are classed as long-term or short-term.  You need to determine this in order to calculate your net capital gain or loss appropriately. In general, if you retain the asset for longer than a year before selling it, your capital gain or loss will be long-term. Your capital gain or loss will be short-term if you retain it for one year or less. There are exceptions to this rule.  For example, any property received as a gift, property obtained from a decedent, and patent property.

Unrecaptured section 1250 gains are a form of capital gains.  As a result, they can be offset by capital losses. To do so, capital losses must be recorded and the amount of the loss may differ depending on whether it is short-term or long-term in nature. A capital loss must be determined to be short-term or long-term in order to offset a capital gain. A short-term loss cannot be offset by a long-term gain and vice versa.

Capital Gain Tax Rates

For most individuals, the tax rate on most net capital gains is no more than 15%. There are also minimum thresholds.  For example, if your taxable income is less than or equivalent to $40,400 for singles, $80,800 for married filing jointly, or eligible widow.  In those cases, some or all of your net capital gain may be taxed at 0%.

The tax rate on most net capital gains is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than or equal to $40,400 for single or $80,800 for married filing jointly or qualifying widow(er). A capital gain rate of 15% applies if your taxable income is more than $40,400 but less than or equal to $445,850 for a single; more than $80,800 but less than or equal to $501,600 for married filing jointly or qualifying widow(er); more than $54,100 but less than or equal to $473,750 for the head of household or more than $40,400 but less than or equal to $250,800 for married filing separately. However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate. (Source: irs.gov)

Example of Unrecaptured Section 1250 Gain

Consider a property that was originally purchased for $300,000 and the owner claims $60,000 in depreciation.  Therefore, the adjusted cost basis for the property is $240,000. If the property is later sold for $370,000, the owner will have realized a gain of $130,000 above the adjusted cost basis. Because the property sold for more than the adjusted cost basis, the unrecaptured section 1250 gains are calculated on the difference between the adjusted cost basis and the original purchase price.

The first $60,000 of profit is subject to the unrecaptured section 1250 gain provision.  The remaining $70,000 is subject to ordinary long-term capital gains taxation. As a result, $60,000 is liable to the higher capital gains tax rate of up to 25%. The remaining $70,000 would be taxed at the 15% long-term capital gains rate.

Up Next: Attestation Meaning – What Is Attestation?

Attestation MeaningAttestation Meaning: Witnessing the signing of a legal document and verifying with your signature that the individuals correctly signed it.  It is the act of witnessing someone sign a legal document, such as a will or power of attorney, and then signing your own name. When a document is witnessed in this manner it is called attesting. That is, testifying and verifying that the person you witnessed signing the paper actually did so in your presence. Attesting to a document does not imply that you are endorsing its correctness or veracity. You are simply stating that you witnessed it being signed by the individual whose name appears on the signature line.

In other words, attestation is the act of witnessing the endorsement of a formal document.  Then, sign it to verify that it was properly signed by those bound by its contents. It is a legal acknowledgment of the authenticity of a document and a verification that proper processes were followed.  The person verifying the authenticity or validity of something or someone is called the attester. These assertions of truth are usually confirmed in writing to certify the statements.

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