SECTION 1250

Definition

SECTION 1250: Section 1250 of the Internal Revenue Code addresses gains realized from real estate properties on which accelerated depreciation was previously claimed. Accelerated depreciation methods allow property owners to deduct greater depreciation expense in the early years of the life of the asset. However, after 1986, straight-line depreciation became mandatory for most buildings, limiting the application of accelerated depreciation and consequently the relevance of Section 1250.

Examples

Pre-1986 Residential Property Sale: If an investor sells a residential property that they owned before 1986 and used accelerated depreciation to reduce their taxable income, any gain from the sale might be subject to Section 1250. This means any excess over straight-line depreciation could be treated as ordinary income instead of capital gains.
Commercial Real Estate: A company that owns a commercial building purchased before 1987 may have utilized accelerated depreciation. Upon selling the building, part of the profit could be subject to recapture as ordinary income according to Section 1250, depending on the method of depreciation previously applied.

Frequently Asked Questions

Q1: How does Section 1250 depreciation recapture work?

A1: Section 1250 depreciation recapture involves treating the portion of the gain from the sale of property attributable to excessive depreciation (discounting straight-line depreciation) as ordinary income, rather than as a capital gain.

Q2: Does Section 1250 still apply to properties purchased after 1986?

A2: Generally, no. Post-1986 properties use straight-line depreciation, mitigation Section 1250’s affect because it is limited to excess accelerated depreciation.

Q3: How is recaptured depreciation taxed?

A3: Recaptured depreciation under Section 1250 is usually taxed as ordinary income up to the amount of depreciation claimed.

Q4: Why did the tax code transition to straight-line depreciation in 1986?

A4: The Tax Reform Act of 1986 aimed to simplify the tax code and prevent individuals from exploiting accelerated depreciation to excessively reduce their taxable income early on in a property’s life.

Depreciation Recapture: A tax provision requiring taxpayers to pay taxes at ordinary income rates on the profit gained from the sale of depreciated property.
Straight-Line Depreciation: A method of depreciating property evenly over its useful life.
Accelerated Depreciation: Any depreciation method that allows greater deductions in the early years of an asset’s life.
Capital Gains: The profit realized from the sale of property categorized for capital gain tax purposes.
Internal Revenue Code (IRC): The body of law governing federal tax laws in the United States.

Online Resources

References

Internal Revenue Code, Section 1250. Retrieved from IRS Website
Tax Reform Act of 1986. Public Law No: 99–514.
Depreciation Recapture Guidelines. (n.d.). Retrieved from Investopedia

Suggested Books for Further Studies

“The Book on Tax Strategies for the Savvy Real Estate Investor” by Amanda Han & Matthew MacFarland
“Taxation for Real Estate Transactions: An Advanced Guide” by William H. Byrnes
“J.K. Lasser’s Your Income Tax Professional Edition 2021” by J.K. Lasser Institute

Real Estate Basics: SECTION 1250 Fundamentals Quiz

### What type of depreciation is addressed specifically under Section 1250? - [ ] Straight-line depreciation - [x] Accelerated depreciation - [ ] Tangible property depreciation - [ ] Uniform depreciation > **Explanation:** Section 1250 addresses gains from real estate where accelerated depreciation, not straight-line depreciation, had been claimed. ### What happens to the portion of gain attributable to excessive depreciation under Section 1250? - [ ] It is treated as capital gains. - [x] It is treated as ordinary income. - [ ] It is exempt from taxation. - [ ] It is subject to a depreciation allowance. > **Explanation:** Gains attributable to excessive depreciation under Section 1250 are treated as ordinary income rather than capital gains. ### When did the Tax Reform Act that mandated straight-line depreciation come into effect? - [ ] 1976 - [ ] 1996 - [ ] 1970 - [x] 1986 > **Explanation:** The Tax Reform Act of 1986 enforced the use of straight-line depreciation for most buildings, reducing the scope of accelerated depreciation. ### Straight-line depreciation became mandatory in order to: - [x] Simplify the tax code and prevent exploitation by property owners. - [ ] Increase the amount of total deduction available. - [ ] Reduce the tax burden on property owners. - [ ] Encourage investment in real estate. > **Explanation:** The Tax Reform Act mandated straight-line depreciation to simplify the tax code and prevent property owners from excessively lowering taxable income early in an asset's life. ### What type of properties does Section 1250 mainly affect post-1986? - [ ] Residential properties both old and new. - [x] Pre-1986 residential and commercial properties using accelerated depreciation. - [ ] Modern commercial buildings too. - [ ] Manufacturing plants built after 1986. > **Explanation:** It mainly affects properties bought or constructed before 1986 when accelerated depreciation was still applicable. ### Why is straight-line depreciation preferred under the new tax code? - [x] It offers simplicity and consistency over an asset’s life. - [ ] It allows greater deductions early on. - [ ] It maximizes tax advantages for property owners. - [ ] It does not require detailed record-keeping. > **Explanation:** Straight-line depreciation is preferred because it simplifies the tax code and provides consistency in deductions over an asset’s useful life. ### Under Section 1250, recaptured depreciation is taxed as what? - [x] Ordinary income - [ ] Long-term capital gains - [ ] Short-term capital gains - [ ] Corporate tax rate > **Explanation:** Recaptured depreciation under Section 1250 is taxed as ordinary income up to the amount of accelerated depreciation claimed. ### What is one outcome of the Tax Reform Act of 1986 on real estate depreciation? - [ ] Allowed faster deductions in the beginning. - [ ] Exempted real estate from taxes. - [x] Mandated the use of straight-line depreciation. - [ ] Introduced capital gain recapture. > **Explanation:** The Tax Reform Act of 1986 mandated the use of straight-line depreciation for real estate properties. ### Why was accelerated depreciation considered exploitable? - [ ] It provided no tax benefit. - [ ] It did not affect property sales. - [ ] It was not legally clear. - [x] It allowed property owners to significantly lower taxable income early in an asset's life. > **Explanation:** Accelerated depreciation was exploitable as it let property owners substantially reduce taxable income in the early stages of an asset's life compared to its straight-line depreciation counterpart. ### How are gains from the sale of properties subject to Section 1250 typically treated? - [ ] As deductible expenses. - [x] Partly as capital gains and partly as ordinary income. - [ ] As long-term gains only. - [ ] Fully tax-exempt. > **Explanation:** Gains from the sales of properties that fall under Section 1250 are split, with part treated as ordinary income (up to the amount of accelerated depreciation claimed) and the rest potentially treated as capital gains.