Unrecaptured Section 1250 gain is the part of a condemnation award that returns the depreciation taken on buildings, and it is taxed at a maximum federal rate of 25 percent. Section 1245 recapture is the part that returns the depreciation taken on equipment and other personal property, and it is taxed as ordinary income. They are two calculations, under two Code sections, at two rates, and only one of them can be deferred with a Section 1033 election. Allocating the award between the two is not the eminent domain attorney’s job. It takes someone who knows the tax code and the avenues in it that can limit the tax, brought in early enough to use them.
The short version. Part of the money for buildings is taxed at up to 25 percent and can be deferred by buying replacement property in time. The money for equipment is taxed like wages in the year it arrives and cannot be deferred. Both numbers have to be known before the settlement is signed.
Getting the split right before the money arrives decides two things: how much cash the owner must hold back for tax in the year of the taking, and how much of the gain a Section 1033 election can actually defer.
Section 1245 recapture: the part that cannot be deferred
Section 1245 applies to depreciable personal property and to tangible property that is not a building or a structural component of one: machinery, fencing, irrigation systems, storage structures, vehicles, and similar assets. When those assets are condemned, or when part of the award is allocable to them, the depreciation previously taken on them is recaptured as ordinary income in the year the proceeds are received.
The critical point is that a Section 1033 election does not defer Section 1245 recapture. Even with a timely election and qualifying replacement property, the recapture amount is recognized as ordinary income in the year the condemnation proceeds arrive. The deferral reaches only the part of the gain that is not Section 1245 recapture.
For owners whose condemned property carries significant equipment or other personal property, which is common in agricultural takings, pipeline corridors and industrial condemnations, this is a cash-flow question that has to be answered before the check clears. The tax on the recapture is owed regardless of what the owner does with the proceeds. Bringing a tax specialist in early in the condemnation gives the owner time to understand the tax burden and to find the other provisions that may limit it. The calculation itself is the subject of a companion piece, Section 1245 recapture in a condemnation.
Unrecaptured Section 1250 gain: the part that can be
Section 1250 applies to depreciated real property, meaning buildings and their structural components. For commercial property held and depreciated over a long period, the accumulated depreciation on the improvements produces unrecaptured Section 1250 gain, which is taxed at a maximum federal rate of 25 percent, separate from and in addition to the capital gain on appreciation above original cost. The same rule is the one landlords meet when they sell a rental; it is described from that side in our page on selling a rental property.
Unlike Section 1245 recapture, unrecaptured Section 1250 gain may be deferred under Section 1033 if the owner makes a timely election and acquires qualifying replacement property within the replacement period. The gain is not erased. It carries into the basis of the replacement property, and recognition is postponed until that property is eventually sold or otherwise disposed of. The 1033 exchange rules that govern the election and the replacement period are set out on our 1033 Exchange page.
Why the distinction matters for planning
The separation matters for two reasons.
Cash flow in the year of the taking. An owner who understands that Section 1245 recapture is owed as ordinary income in the year of receipt, regardless of reinvestment, can plan for that obligation. An owner who assumes the Section 1033 election covers everything meets an unexpected tax bill at filing. This is the most common planning failure in condemnation cases, and it is entirely avoidable.
Structuring the reinvestment. Knowing the split between the two kinds of recapture lets the tax team structure the Section 1033 election to get the full benefit of deferral on the part that can be deferred. It also sets the real figure available for reinvestment: the award, less the cash that must be held for the tax that cannot be deferred.
Quick reference: § 1245 against § 1250
Section 1245. Personal property and equipment. Taxed as ordinary income. Recognized in the year of receipt regardless of a Section 1033 election. Cannot be deferred.
Section 1250. Depreciated buildings and structural components. Unrecaptured Section 1250 gain, at a maximum federal rate of 25 percent. May be deferred if the Section 1033 election is properly made and replacement property is acquired within the replacement period.
This is why the right tax specialist needs to be working with the owner early: to run both calculations in time, and to help the owner plan for the tax that follows. One clarification, because elsewhere we tell attorneys that less is best in the settlement document: this split is planning arithmetic for the owner’s tax team and its close-out file, not language for the settlement agreement. The agreement stays simple; the analysis sits behind it.
What this means before the award arrives
The recapture analysis is not a tax-return exercise. It is a pre-closing planning tool. Before the condemnation proceeds are received, the tax team should estimate the Section 1245 exposure, which is the cash obligation that cannot be deferred, and the Section 1250 exposure, which is the amount a properly structured Section 1033 election may defer.
Owners who understand this before closing make better reinvestment decisions and avoid a tax bill they did not expect. Owners who learn it at tax time have fewer options and less room to move. That is the reason our work starts before the settlement is signed, not after.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. We calculate the basis and the recapture exposure early, ideally before any deposit is taken, sequence the Section 1033 election with the owner’s CPA, and give the attorney the tax picture before terms are final. If the numbers say the owner does not need us, we say so. The first call is free.
Frequently asked questions
What is unrecaptured Section 1250 gain? It is the part of the gain on depreciated real property that represents the depreciation deductions previously taken on buildings and structural components. Federal law taxes it at a maximum rate of 25 percent rather than the lower long-term capital gains rates.
Can a 1033 exchange defer depreciation recapture? Partly. Unrecaptured Section 1250 gain on buildings can be deferred with a timely Section 1033 election and qualifying replacement property. Section 1245 recapture on equipment and other personal property cannot; it is ordinary income in the year the proceeds are received.
What is the depreciation recapture tax rate in a condemnation? Two rates apply. Section 1245 recapture is taxed at the owner’s ordinary income rate. Unrecaptured Section 1250 gain is taxed at a maximum federal rate of 25 percent, plus state tax where it applies.
Not sure what the recapture split looks like on a specific award? A free thirty-minute call with Steve Medendorp walks through the Section 1245 and Section 1250 pieces and how the Section 1033 election can be structured before the proceeds arrive. The earlier the analysis, the more options the owner has.
