Section 1245 recapture reaches further than most disposals expect

Equipment gets sold, traded or scrapped constantly, and the disposal usually looks like a small entry. A piece of machinery bought for 60,000 and depreciated to nothing sells for 18,000. There is a gain of 18,000, and the question is what kind.

Under §1245, all of it is ordinary income.

That is the characteristic of this regime and the reason it deserves attention out of proportion to the size of the transaction: §1245 does not recapture a portion of the depreciation or the excess over some baseline. It reaches the whole of it, up to the entire gain.

The computation is a lesser-of, and both sides come from history

Recapture under §1245 is the lesser of the depreciation allowed or allowable on the property, or the gain realised on the disposition. Any gain beyond that amount is characterised under §1231.

For fully depreciated equipment sold below original cost, the depreciation figure exceeds the gain, so the lesser-of resolves to the gain and the entire thing is ordinary. That is the ordinary case, and it is why the answer for most equipment disposals is simply "all of it".

Both inputs to that comparison depend on records rather than on this year's transaction. The gain needs adjusted basis, which needs accumulated depreciation. The recapture ceiling is that same accumulated figure. A disposal is arithmetic performed on a depreciation history.

§179 and bonus are depreciation for this purpose

Worth stating explicitly because the deductions felt different when they were claimed.

A §179 expense deduction is treated as an amount allowed for depreciation in applying §1245, and so is the special depreciation allowance. An asset expensed in full under §179 in year one has a depreciation history equal to its cost, even though no depreciation schedule ever showed it being written down over a life.

This is why an asset that never appeared to depreciate can produce a fully ordinary gain on sale. The client's recollection — "we wrote that off the year we bought it" — describes exactly the situation that maximises recapture.

What counts as §1245 property is broader than equipment

The intuition is that §1245 means machinery and §1250 means buildings. Roughly true, and it has edges that matter.

§1245 property is depreciable personal property, tangible and intangible, along with several specific categories of real property — including single-purpose agricultural and horticultural structures and storage facilities used for the distribution of petroleum. Amortisable intangibles picked up in an acquisition sit here too.

The edge that shows up most often in practice runs through buildings. A cost segregation study reclassifies parts of a building — fixtures, dedicated electrical, land improvements — into shorter recovery periods, and much of what it reclassifies is §1245 property rather than §1250. The study is usually done for the acceleration; the disposal consequence arrives later, when those components carry full recapture rather than the gentler §1250 treatment. Both facts are properties of how the assets were classified when they were set up, which is to say properties of the schedule.

Two escapes that used to exist and one that never did

Like-kind exchange, for equipment, is gone. §1031 applies only to real property for exchanges completed after 2017. A machinery trade-in that would once have deferred the gain is now a disposition, and the recapture is current.

Installment reporting does not defer it. Under §453(i), recapture income is recognised in the year of the disposition regardless of the installment method, and it is then added to basis for computing gross profit on the remaining payments. A seller who spread the price over five years still reports the full ordinary component immediately — which is a cash-flow surprise rather than a tax-rate surprise, and it lands on the return before most of the money does.

Gifting does not reset it. A transferee generally takes the transferor's basis and the depreciation history rides along with it.

Where the number comes from, and what can be wrong with it

The recapture ceiling is accumulated depreciation on that asset, and the only record of it for an inherited client is whatever the prior preparer's schedule printed.

Three ways that record goes wrong in transit, all invisible at the moment they happen.

A prior figure carried over too low. The asset then shows more remaining basis than it has, the gain on sale is understated, and so is the recapture. Nothing in the file indicates a problem because the schedule that produced the figure footed correctly.

Components read as zero when the source simply did not print them. A combined prior depreciation column is sufficient for the §1245 ceiling — the total is the total. The zeros matter elsewhere, in §179 recapture on a business-use drop and in state basis, which is what prior depreciation is actually carrying.

The wrong report transcribed. An AMT copy or a book copy of the same asset list carries different accumulated figures and foots perfectly against its own totals.

The check is arithmetic. Sum the prior depreciation of the rows in a group and compare it against the subtotal the schedule printed for that group, then do the same for cost. A dollar's tolerance covers the rounding printed schedules use; anything larger is a row, not rounding. That tie-out is the only independent evidence that the history you are about to rely on is the history the prior firm recorded.

What we do with it

Accumulated depreciation is transcribed as the schedule printed it, and the import file is not downloadable until the summed rows agree with the printed totals for cost, prior depreciation and current depreciation. Nothing is computed and nothing is reconstructed.

Where a print does not separate prior §179 and prior bonus, those come back empty and flagged rather than zeroed. For the §1245 ceiling the combined figure is what matters, so the conversion is complete in that respect — but the components drive other outcomes, and a zero there would be a claim the document does not support. The wider mechanics are in the depreciation recapture guide, and the job of getting an inherited schedule into your own system is the prior year depreciation schedule for a new client.

FAQ

What is section 1245 recapture?

On disposal of §1245 property, gain is characterised as ordinary income up to the lesser of the depreciation allowed or allowable on the property, or the gain realised. Any remaining gain is characterised under §1231. It is reported on Form 4797.

Does §179 expense count as depreciation for recapture?

Yes. A §179 deduction is treated as an amount allowed for depreciation in applying §1245, and so is the special depreciation allowance. An asset expensed in full in its first year carries a depreciation history equal to its cost.

Can an installment sale spread §1245 recapture over the payment years?

No. Under §453(i) the recapture income is recognised in the year of disposition regardless of the installment method, and that amount is added to basis for computing gross profit on the remaining payments.

Is a trade-in of equipment still a like-kind exchange?

Not for exchanges completed after 2017. §1031 applies only to real property, so a personal-property trade-in is a disposition and any recapture is current.

Can part of a building be §1245 property?

Yes. A cost segregation study reclassifies components such as fixtures, dedicated electrical and land improvements into shorter recovery periods, and much of what it reclassifies is §1245 property carrying full recapture rather than §1250 treatment.

What if the prior preparer's schedule shows less depreciation than was allowable?

The measure is depreciation allowed or allowable, so the amount that could properly have been taken counts whether or not it was claimed. A schedule showing less than the allowable amount is worth resolving before a disposal rather than during one.