Real estate depreciation recapture.

• Author: Reilly, Kevin F.

Philip Skalka, TC Summ. Op. 2003-107, serves as a reminder that not all real estate depreciation recapture by individual taxpayers is taxable at the 25% rate enacted by the Taxpayer Relief Act of 1997 (TRA '97).The Tax Court reiterated that Sec. 1250 gain recapture on a sale or exchange of real property is still ordinary income.

Background

Under Sec. 1250(c), "Sec. 1250 property" is any real property subject to the allowance for depreciation that is not Sec. 1245 property. For property held more than one year, gain realized on the disposition of Sec. 1250 property is recaptured as ordinary income, to the extent that the depreciation allowed or allowable exceeds the depreciation that would have resulted under the straight-line method; see Sec. 1250(a) and (b). Under Sec. 1250(a)(1)(A), Sec. 1250 gain is recognized as ordinary income, notwithstanding any other provisions of subtitle A of the Code.

According to the Tax Court in Skalka, the TRA '97 amended Sec. 1(h) to include Sec. 1(h)(1)(B) (current Sec. 1(h)(1)(D)), which taxes unrecaptured Sec. 1250 gain at a 25% capital gain rate. Sec. 1(h)(6)(A) defines "unrecaptured Sec. 1250 gain" as the amount of long-term capital gain that would be treated as ordinary income if Sec. 1250(b)(1) included all depreciation (i.e., all depreciation allowed or allowable on the property).

The unrecaptured Sec. 1250 gain definition in the TRA '97 would appear to effectively eliminate any Sec. 1250 gain being recaptured as ordinary income, because all the depreciation is deemed unrecaptured Sec. 1250 gain, taxed at 25%. However, because the Sec. 1250 gain rules apply notwithstanding any other provisions of Subtitle A of the Code and Sec. 1(h) is included in Subtitle A, the Sec. 1(h)(6)(A) definition of unrecaptured gain cannot override the Sec. 1250(a) ordinary income treatment of Sec. 1250 gain recapture.

Recognizing this conflict, Congress included technical corrections in the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) that revised and clarified the definition of unrecaptured Sec. 1250 gain under the TRA '97. Under the IRSRRA '98, the definition of unrecaptured Sec. 1250 gain in Sec. 1(h)(6)(A) was amended to include long-term capital gain not otherwise treated as ordinary income. Under Section 6024 of the IRSRRA '98, the amendment took effect as if included in the TRA '97.

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