Noting that with all Sec 1231 property (Sec 1245 or Sec 1250) a realized loss is treated as Ordinary Income loss (OI) and depreciation is not recaptured as part of that loss.
Responding to the poster above, Sec. 1250 refers to Sec. 1231 property that is real property such as buildings that has never been Sec. 1245 property. What the poster referred to was that pre-1986 (I believe) you could have use a non-SL. Since then you cannot.
Anecdotally, it's important to know that Unrecaptured Sec. 1250 gain was created to close a perceived loophole whereby sellers of Sec. 1250 property were gaining a depreciation expense advantage.
Example of Unrecaptured Sec 1250 Gain:
Taxpayer paid $27,500 for a rental property in 2010 and sold the property in 2020 for $50k
Easy math is 10 years of 1/27.5 of the cost = accumulated depreciation = $10k
Adjusted basis of the property = 27.5k - 10k = 17.5k
Realized gain on the sale = 50k - 17.5k = 32.5k (we're assuming on cost of sale for ease of example)
Of 32.5k, the first 10k will be unrecaptured Sec. 1250 gain, while 22.5k will be considered capital gains.
In this example if the taxpayer remained in a 18% effective tax rate throughout the duration of ownership, they achieved a tax benefit of $1,800 (18% of $10k) thru depreciation. That also puts their taxable income ~60k if single.
Let's dig into the numbers:
If there's no other capital gains from equities, etc., then total Schedule D would report $32,500.
The Sch D tax calculation worksheet would show what is being taxed at 0/15/20 or 25% rates
0%: $2,500
15%: $20,000
20%: $0
25%: $10,000
28%: $0
That gives the total of $32,500 the correct taxation of $10k @ 25% (Unrecaptured Sec 1250) while the residual $22,500 is split between 0% and 15%.
Capital Gains tax would be: $5,500 (of which $2,500 was Unrecaptured Sec. 1250).
This is why I believe Sec. 1250 unrecaptured depreciation should be revised
1. Tax benefit of depreciation over 10 years: $1,800
2. Sec. 1250 unrecaptured depreciation: $2,500
3. Capital Gains cost of subtracting accumulated depreciation from purchase price to achieve adjusted basis: $1,125
Total benefit of depreciation to taxpayer: $1,800
Total cost of depreciation to taxpayer upon sale: $3,625
This taxpayer was penalized over 200% of their benefit because depreciation benefits are already eroded by lowering the basis, thus increasing capital gains at 0/15/20 tax rates and then compounding that with 25% of this eclipses any effective tax rates below 20%
Instead, Congress should change the code to allow for accumulated depreciation to have an accumulated benefit amount be used during the sale year and make sure that after calculating the capital gains, the smaller of the accumulated benefit and 25% of the accumulated depreciation should be Sec 1250 recapture. Then although paying more capital gains because of the depreciation, at least the 1250 recapture would not exceed the gain from depreciation.
