Section 1245 recapture is the ordinary-income tax on the depreciation previously taken on equipment and other personal property included in a condemnation award. It is owed in the year the proceeds are received, and a Section 1033 election does not defer it. In pipeline corridor takings and agricultural condemnations it is often the largest tax the owner cannot plan around, which is exactly why it has to be calculated before the settlement closes rather than discovered at filing. Determining that burden is not the eminent domain attorney’s job. What matters is that the owner has a tax specialist in their corner early, so the tax consequences are planned for as early in the condemnation as possible.
The short version. The money in the award that pays for equipment, fencing, irrigation and the like is taxed like wages in the year it arrives, and buying replacement property does not change that. Know the number before signing, and set the cash aside.
What Section 1245 property covers
Section 1245 applies to depreciable personal property and to any other tangible property, other than a building or its structural components, that has been subject to depreciation deductions. In a condemnation this commonly includes machinery and equipment used in the business; fencing, gates and perimeter structures; irrigation systems, wells and pumping equipment; storage tanks and bins not permanently attached to a building; and vehicles and rolling stock.
In pipeline corridor takings and agricultural condemnations, Section 1245 property is often significant. A farm operation may carry substantial fencing, irrigation and equipment on the condemned tract, and each of those assets contributes to the recapture calculation.
The calculation the IRS expects
Section 1245 recapture is the lesser of two figures: the depreciation deductions previously allowed or allowable on the property, or the gain recognized on its disposition. In a condemnation, the gain on each Section 1245 asset is the difference between the proceeds allocable to that asset and its adjusted basis at the time of the taking.
The recapture is reported as ordinary income on Form 4797, Part III, in the year the proceeds are received. It is taxed at the owner’s ordinary income rate, which reaches 37 percent federally at the top bracket, plus state tax where it applies. It is not capital gain, and it is not the same calculation as the unrecaptured Section 1250 gain on buildings, which has its own rate and its own deferral rule; the two are compared side by side in our article on unrecaptured Section 1250 gain in a condemnation.
Keep the settlement simple
On how the award is documented, our position is consistent: less is best. Identifying the components inside the award is a matter for the owner’s CPA and tax professionals, and they should be given the most flexibility possible. Unless the litigation or the settlement terms require a particular characterization, keep the formal documents clean and let the professionals do the analysis on the back end. The page written for those professionals, Section 1033 for CPAs and attorneys, sets out what they will need.
Practitioner note. The Section 1245 calculation must be run before the award closes, not at tax time. The number determines how much cash the owner owes as ordinary income regardless of reinvestment, and it has to be part of the reinvestment decision before the wire arrives. An owner who reinvests the whole award and then owes Section 1245 recapture in April has a liquidity problem that a thirty-minute pre-closing analysis would have prevented.
Why the pre-closing calculation matters
The Section 1245 liability is fixed at closing. It does not change with what the owner does afterward. An owner who reinvests the entire award in qualifying replacement property under the 1033 exchange rules will defer the real property gain, and will still owe ordinary income tax on the Section 1245 recapture in the year of receipt.
The pre-closing calculation does two things. It lets the owner set aside enough cash for the tax before deploying the rest into replacement property. And it produces the accurate net-available-for-reinvestment figure that decides whether the owner can fully defer the real property gain or will recognize some of it regardless.
Before the deposit, not after
The most useful moment for this calculation is earlier than most people expect: before the deposit is negotiated. The goal is for the owner’s tax team to calculate the adjusted basis of the property being taken and the recapture that rides on it, and to hand the attorney that picture before the deposit is set. The reason is the clock. When the owner receives a deposit that exceeds the property’s basis, gain is realized in that year, and the Section 1033 replacement period runs from the end of it. A deposit taken without the basis in hand can start a clock nobody knew was running.
The bottom line
Section 1245 recapture in a condemnation is not a surprise that arrives at tax time. It is a predictable, calculable liability that belongs in every condemnation tax conversation before the settlement closes, and ideally before the deposit. The attorney who raises it early gives the owner’s tax team what they need to structure the reinvestment decision correctly.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. We calculate the basis and the Section 1245 exposure before the deposit, sequence the Section 1033 election with the owner’s CPA, and give the attorney the tax picture before the deposit and the terms are final. If the owner does not need us, we say so. The first call is free.
Frequently asked questions
Does a Section 1033 election defer Section 1245 recapture? No. The election defers gain on the property itself. Section 1245 recapture is ordinary income in the year the proceeds are received, whatever the owner does with them.
Where is Section 1245 recapture reported? On Form 4797, Part III, for the year of receipt, as ordinary income.
What counts as Section 1245 property in a taking? Depreciated equipment, machinery, fencing, irrigation, wells and pumps, tanks and bins not attached to a building, vehicles, and other tangible property that is not a building or a structural component of one.
Have a client or a property with equipment in the taking? A free thirty-minute call with Steve Medendorp runs the Section 1245 split before the award closes.
