How to Compute Depreciation Recapture on Form 4797
Compute depreciation recapture on Form 4797 by separating accumulated depreciation between Section 1245 personal property (recaptured at ordinary rates) and Section 1250 real property (unrecaptured 1250 gain capped at 25%). Total gain less Section 1245 recapture less unrecaptured 1250 equals long-term capital gain. Add NIIT at 3.8% on all three tiers for taxpayers over the income threshold.
Step 1: Compute adjusted basis and total gain
Adjusted basis equals original cost (excluding land) minus accumulated depreciation. Total gain equals sale price minus adjusted basis. The character of the gain is split across three tiers based on the depreciation history.
For a $1.2M sale on a property with $1M original cost (excluding $200K land) and $400K accumulated depreciation, adjusted basis is $600K. Total gain is $1.2M minus $600K equals $600K. The $600K splits across recapture, unrecaptured 1250, and LTCG.
Step 2: Section 1245 recapture computation
Section 1245 recapture is the lesser of total gain or the accumulated depreciation on Section 1245 property (5-year personal property and 15-year land improvements from a cost seg study). It is taxed at ordinary income rates.
If $280K of the $400K accumulated depreciation was on 5-year and 15-year reclassified property, Section 1245 recapture is the lesser of $600K (total gain) or $280K (accumulated 1245 depreciation), so $280K. At a 37% ordinary rate, that is $104K of federal tax.
Step 3: Unrecaptured Section 1250 gain
After Section 1245 recapture, the next tier is unrecaptured Section 1250 gain: the portion of the remaining gain attributable to depreciation on real property (27.5-year residential or 39-year nonresidential). Capped at 25% federal rate under IRC Section 1(h)(1)(E).
Remaining gain after Section 1245: $600K minus $280K equals $320K. Of that, the portion attributable to accumulated 1250 depreciation ($120K in this example) is unrecaptured 1250 gain. At 25% federal: $30K. The balance ($200K) is regular LTCG.
Step 4: Long-term capital gain plus NIIT
Regular LTCG is taxed at 0% / 15% / 20% based on income. For a top-bracket taxpayer, $200K LTCG at 20% is $40K federal.
Net Investment Income Tax under IRC Section 1411 adds 3.8% on all three tiers for taxpayers over $200K single / $250K MFJ modified AGI. On the full $600K gain: $22.8K additional. NIIT is not assessed on the cost basis or excluded portion. Only on the gain.
| Tier | Amount | Rate | Federal tax |
|---|---|---|---|
| Section 1245 recapture | $280K | 37% ordinary | $104K |
| Unrecaptured 1250 | $120K | 25% cap | $30K |
| LTCG | $200K | 20% | $40K |
| NIIT (3.8% on $600K) | $600K | 3.8% | $22.8K |
| Total federal tax | $196.8K |
Step 5: File Form 4797 with the return
Form 4797 reports gains and losses from the sale of business property. Part III handles the Section 1245 and Section 1250 recapture computation. Part I handles the LTCG portion. Schedule D consolidates the gain into the individual return.
Coordinate with your CPA on the entity level (partnership or S-corp K-1 reporting) if the property is held through a flow-through entity. The form mechanics are the same. Only the reporting path differs.
Frequently asked questions
- How does WeCostSeg coordinate with my CPA?
- Every engagement follows the three-touch CPA Coordination Protocol. We send a preliminary analysis to your CPA on intake, share the draft report five business days before final delivery, and coordinate Form 3115 filing timing when a Section 481(a) adjustment applies. Your CPA never pays a fee.
- Does this analysis assume 100% bonus depreciation under OBBBA?
- Yes for property acquired with a binding contract on or after January 20, 2025 under Public Law 119-21. Property under a binding contract on or before January 19, 2025 stays on the legacy phase-down: 40% bonus in 2025, 20% in 2026, 0% in 2027 and after.
- Is the five-year audit defense included?
- Yes. Every WeCostSeg engagement includes five years of written audit defense at no extra cost. The defense aligns to the 13 Principal Elements of a Quality Cost Segregation Study under IRS Publication 5653 Chapter 4.
- Can I get a free preliminary analysis?
- Yes. Submit your property details via the free proposal form or WhatsApp. Our engineer returns a written estimate of your first-year deduction within four business hours during US Eastern hours. No payment, no contract.
- Does a 1031 exchange defer the Form 4797 reporting?
- The exchange is reported on Form 8824 instead. Form 4797 reports the taxable portion if boot is received. Pure exchanges with no boot defer all gain.
Zawwad Ul Sami, Founder
Zawwad Ul Sami is the founder of WeCostSeg, a founder-led cost segregation firm serving real estate investors across the US. He focuses on strategy, pricing, and the firm's overall direction.