Final answer:
The gain from Section 1245 depreciation recapture on an installment sale is recognized as ordinary income in the year of the sale, while the remaining gain can be spread out over the period payments are received and taxed at capital gains tax rates.
Step-by-step explanation:
When an installment sale involves Section 1245 depreciation recapture, the gain is recognized in a specific manner. Under Section 1245, the portion of the gain representing the depreciation recapture must be reported as ordinary income in the year of the sale. This is separate from the rest of the gain which may be reported under the installment method. The depreciation recapture amount is the lesser of the cumulative depreciation taken on the asset or the gain on the sale, and it is taxed at ordinary income tax rates regardless of the installment plan.
For the remaining gain on the installment sale, excluding the depreciation recapture amount, if the installment payment stretches over multiple years, the seller can recognize the gain over the period that the payments are received. This portion of the gain is typically taxed at the capital gains tax rate. It's essential for the seller to calculate the proportion of each installment payment that is attributable to the recaptured depreciation versus the capital gain to report the income correctly.