Selling a Building Depreciated Under ACRS: Why the Recapture Can Be Ordinary Income

What ACRS covered and for which buildings

The Accelerated Cost Recovery System (ACRS) replaced the old useful-life depreciation rules for property placed in service after 1980.

The Instructions for Form 4562 say ACRS is mandatory and generally applies to tangible property placed in service after 1980 and before 1987, and that if you placed property in service in that period you must continue to figure depreciation under ACRS.

For real property the recovery period depended on the date placed in service.

Both later laws carry exceptions for property placed in service before 1987 under a binding contract, or with construction started, before the cutoff date (P.L. 98-369, sec. 111(g)(2); P.L. 99-121, sec. 105(b)(2)).

A building you bought in mid-1984 under a contract signed in 1983 can therefore still be 15-year property. The accelerated percentages came from a table the Treasury issued, built on the 175 percent declining balance method and switching to straight line (P.L. 97-34, new IRC 168(b)(2)).

The Tax Reform Act of 1986 replaced ACRS with MACRS for property placed in service after December 31, 1986, and let taxpayers elect MACRS for property placed in service after July 31, 1986 (P.L. 99-514, sec. 203(a)(1)). So the old rules cover most buildings placed in service between 1981 and mid-1986, and some later ones.

The rule that surprises sellers: accelerated nonresidential buildings are Section 1245 property

Ordinarily a building is Section 1250 property, and recapture reaches only depreciation taken faster than straight line (IRC 1250(b)(1)). ACRS changed that for nonresidential real estate.

The 1981 Act added Section 1245(a)(5), which defined "section 1245 recovery property" as recovery property other than four exceptions: 15-year real property that is residential rental property; property described in Section 168(f)(2); 15-year real property for which the taxpayer elected a different recovery percentage under Section 168(b)(3), meaning the straight-line election; and certain low-income housing (P.L. 97-34, sec.

204(c)). The same Act added recovery-period deductions to the "recomputed basis" used in Section 1245(a)(2) (P.L. 97-34, sec. 204(b)).

Put those together and a nonresidential building on the accelerated tables is Section 1245 property. Selling it triggers ordinary income equal to the lesser of the depreciation taken or the gain (IRC 1245(a)(1)).

That is the full amount of depreciation, not an excess over straight line, and it is taxed at ordinary rates (IRC 1; Rev. Proc. 2025-32, 2026).

The IRS says the same thing in the current Instructions for Form 4797, under Line 26: real property depreciable under ACRS (pre-1987 rules) is subject to recapture under Section 1245, except 15-, 18- or 19-year real property and low-income housing that is residential rental property, that is used mostly outside the United States, or for which a straight-line election was made. Those exceptions are treated as Section 1250 property.

If only part of a building is Section 1245 recovery property, the 1981 Act allocated gain first to that part (P.L. 97-34, sec. 204(c)). Section 1250(d)(11), added by the same Act, turned off the normal Section 1250 recapture for property that is Section 1245 recovery property (P.L. 97-34, sec. 204(e)).

Does the ACRS treatment still apply to a building sold today

Yes, for buildings placed in service before 1987, on the sources we checked. The Tax Reform Act of 1986 struck the Section 1245(a)(5) definition (P.L. 99-514, sec. 201(d)(11)(D)), but those amendments apply only to property placed in service after December 31, 1986 (P.L. 99-514, sec.

203(a)(1)(A)), with an election available for property placed in service after July 31, 1986. Congress later struck the matching Section 1250(d)(11) (P.L. 100-647). Neither change reclassifies a 1981 to 1986 building that stayed on ACRS.

The current Instructions for Form 4797 still carry the ACRS rule above, and the Instructions for Form 4562 still tell taxpayers to report ACRS property on line 16 and refer to Pub. 534 for the rules.

Two precise points matter. First, the statutory text of Section 1245(a)(5) cited here is the 1981 Act's wording; the 1984 and 1985 laws only updated the class names from 15-year to 18-year and then 19-year real property and revised the low-income housing exception (P.L. 98-369, sec.

111(f); P.L. 99-121, sec. 103(b)). Second, we did not find any later authority that changes the result for a pre-1987 building, but a sale this large deserves a CPA who reads the original depreciation schedule instead of relying on a summary.

How the buckets compare

Unrecaptured Section 1250 gain is defined in IRC 1(h)(6) as long-term gain that would be ordinary if Section 1250 reached all depreciation.

It is taxed at a maximum 25% (IRC 1(h)(1)(E)), and the part of the gain above the depreciation is Section 1231 gain, taxed at 0%, 15% or 20% as long-term capital gain (Rev. Proc. 2025-32, 2026; IRC 1231(a)(1)). Add the 3.8% net investment income tax where it applies (IRC 1411).

Read depreciation recapture for the general rules and capital gains tax on commercial property for the post-1986 case.

Worked example: the same building under two methods

A couple bought a commercial building in 1984 and depreciated $800,000 on the accelerated tables until the basis in the building reached zero. They sell in 2026 with $2,800,000 of total gain: $800,000 of depreciation, $1,300,000 of building appreciation and $700,000 of land gain. The example uses 2026 law, a Texas resident and $150,000 of other income, with no carryovers or other adjustments.

Under the accelerated-tables treatment, the $800,000 is ordinary Section 1245 income and the rest is long-term gain. The total tax caused by the sale is $749,011 on $2,800,000 of gain, an effective rate of 26.8%%.

If the same building had a straight-line election, the same $800,000 would be unrecaptured Section 1250 gain taxed at up to 25%, and the tax would be $715,753. The difference is $33,258, which is the cost of having elected, or not elected, straight line decades ago.

Spreading the sale with a five-year note does not remove the difference. Recapture income is recognized in the year of sale and only the gain above it is installment gain (IRC 453(i)).

In the third example the 2026 tax is large because all $800,000 lands that year, and the five-year total is $653,811 against $749,011 for a cash sale. The saving comes only from spreading the $2,000,000 of capital gain. These are illustrative figures; the real split depends on your original schedule.

Installment sales and seller financing

For an ACRS building, the installment method works differently than it does for a post-1986 building.

Section 453(i) says recapture income, the amount that would be ordinary under Section 1245 or 1250 if all payments were received in the year of sale, is recognized in the year of the sale, and any gain beyond it is reported under the installment method.

If the building is Section 1245 recovery property, the entire depreciation is recapture income, so a buyer's note will not defer it. On a straight-line building, unrecaptured Section 1250 gain is not recapture income, so it spreads with the payments and is taken first, before the rest of the gain (Treas. Reg. 1.453-12).

This is why the first question on an old building is how its depreciation is classified. A seller who expects the 25% layer to arrive with the payments, and then finds ordinary recapture due at closing, owes tax on money not yet received.

The rest of a seller-financed deal is also still valuable: the capital gain portion spreads, and a note secured by a deed of trust on the building protects the seller. See installment sale and seller financing.

A 1031 exchange out of an ACRS building

Section 1245(b)(4) is the controlling text.

If property is disposed of and gain is not recognized in whole or in part under Section 1031, the amount taken into account as ordinary income under Section 1245(a)(1) cannot exceed the sum of the gain recognized plus "the fair market value of property acquired which is not section 1245 property."

Treas. Reg. 1.1245-4(d)(1) restates that rule. A replacement building and land are not Section 1245 property. Read on its face, that means swapping a Section 1245 building for ordinary real estate can leave recapture on the table even with no cash received, up to the value of the non-1245 replacement.

What we could not confirm is how Section 1245(b)(4) applies to a pre-1987 ACRS building. Subsection (b)(4) was not rewritten when Congress added and then struck the "recovery property" definition, and we found no ruling, regulation or case that answers it for an ACRS nonresidential building exchanged into real estate.

We state it as a question, not a conclusion: ask your CPA whether recapture is triggered, how much, and whether a straight-line election in the original year changes the answer. Our page on Section 1245 recapture in a 1031 exchange explains the mechanics for cost-segregated components, and the 1031 exchange page covers the exchange rules.

Where to find the method and what the records should show

• The first-year depreciation schedule. The year the building went into service, your return (Form 4562 or whichever schedule your preparer used then) shows the recovery class, the date placed in service, the basis and whether a straight-line election was made. Today the Instructions for Form 4562 direct taxpayers to report ACRS property on line 16.
• Schedule E, line 18. Rental depreciation flows to that line, and the return's depreciation detail shows the running balance.
• Why recent returns show nothing. A building that was 15, 18 or 19 years old by the mid-2000s was fully depreciated. Recent returns list no depreciation on it, which does not mean none was taken. Gain is figured with depreciation allowed or allowable, and basis is reduced either way (IRC 1016(a)(2); see missed depreciation before a sale).
• Land. Land is never depreciable, so the original purchase must have been split between land and building. Look for the closing statement, appraisal or the allocation used on the first return.
• Later improvements. An improvement made after 1986 to property placed in service before 1987 is separate depreciable property under MACRS (Pub. 946), so a building can carry two schedules and two kinds of recapture at once.

If the originals are gone, the closing statement, the lender file and your old preparer's workpapers are the usual substitutes.

What to confirm with your CPA

Before a sale of a pre-1987 building, confirm: the placed-in-service date and class; whether a straight-line election was made; whether the building is residential rental or nonresidential; the land allocation; the amount and timing of any post-1986 improvements; whether the Section 1245 recovery property rules apply to your return; and, if you want a 1031 exchange, how Section 1245(b)(4) applies.

If a sale is coming, get the Big Sale Tax Analysis to model the recapture, a Section 453 installment sale and a 1031 exchange side by side.

How much tax would you owe? Run your own numbers

Frequently asked questions