Depreciation Recapture: What Every Taxpayer Should Know

by Casey Donnelly

Tax Associate at Brewer, Eyeington, Patout & Co., LLP

Depreciation recapture might sound complicated, but it’s an important concept for anyone who owns and sells property or business assets. Essentially, it’s a way for the IRS to “recapture” some of the tax benefits you received from depreciating an asset over time. Let’s dive into what this means and how it affects you.

What is Depreciation?

First, let’s understand depreciation. When you buy a property or an asset for your business, you can deduct a portion of its cost each year as depreciation. It helps spread out the cost of the asset over its useful life.

What is Depreciation Recapture?

When you sell that asset, depreciation recapture comes into play. If you sell the asset for more than its depreciated value (also known as the adjusted or book basis), you might have to pay taxes on the amount you depreciated. This is because the IRS wants to recover some of the tax benefits you received from those depreciation deductions.

Types of Property and How They Are Treated

1. Personal Property (Section 1245): This includes things like machinery, equipment, and vehicles. When you sell these items, any gain up to the amount of depreciation you took is taxed as ordinary income.

2. Real Property (Section 1250): This includes buildings and structures. For these, only the depreciation that exceeds straight-line depreciation (a method that spreads the cost evenly over the asset’s life) is recaptured as ordinary income. The rest is taxed at a lower capital gains rate.

How to Calculate Depreciation Recapture

Here’s a simple way to think about it:

1. Find the Adjusted or Book Basis: This is the original cost minus all the depreciation you’ve taken.

2. Calculate the Gain: Subtract the adjusted basis from the sale price.

3. Determine the Recapture Amount: The recapture amount is the lesser of the total depreciation taken or the gain on the sale.

4. Tax the Recapture: This amount is taxed as ordinary income, while any remaining gain is taxed at capital gains rates.

Why It Matters

Depreciation recapture can increase your tax bill when you sell an asset. It’s important to be aware of this so you can plan accordingly. For example, if you’re selling a piece of equipment or a rental property, knowing about depreciation recapture can help you properly estimate your tax liability.

Tips to Manage Depreciation Recapture

1. Like-Kind Exchanges: You may be able to defer the gain on the sale of the property, by exchanging the asset for a similar one under Section 1031.  However, this is only applicable for real property.

2. Installment Sales: Spreading the sale over several years can help manage the tax impact.

3. Consult a Tax Professional: They can provide strategies tailored to your specific situation.

Depreciation recapture is a key concept for anyone selling depreciated assets. By understanding how it works, you can better prepare for the tax implications and make informed decisions. Always consider consulting with your tax professional to navigate these rules effectively.