Depreciation Recapture
The selling of assets can have a significant impact on your operations. One aspect to consider is depreciation recapture which comes into play when selling depreciable assets, such as equipment, machinery, or real estate used in business.
What is Depreciation Recapture?
When you dispose of or sell assets at a gain, you have to “recapture” the depreciation that has been taken as an expense. The recaptured amount is taxed with ordinary income rates rather than capital gain rates. Any gain above the recaptured amount may be eligible for a more favorable capital gains rate.
Depreciation recapture rules also apply to assets that have been fully depreciated as well as those only partially depreciated. Assets sold at a loss are not subject to depreciation recapture since there is no income.
Tax Treatment of Different Property
Below are two primary types of depreciable assets, also referred to as property, and how depreciation recapture is applied:
- Personal property is typically tangible assets such as equipment, vehicles, machinery, and livestock. This is commonly referred to as section 1245 property. When selling or disposing of this property, all the depreciation that has been taken is subject to recapture as ordinary income.
- Real property, also known as section 1250 property, includes buildings and their structural components. Only depreciation claimed in excess of straight-line depreciation is recaptured as ordinary income. For most modern buildings, this is often zero, but any remaining gain attributable to straight-line depreciation may be taxed at a special 25% rate.
Practical Example
You sell a piece of equipment for $15,000 that has been used in your business for more than a year. The original cost was $20,000 and $12,000 of depreciation was taken while you used the equipment. With the adjusted basis of $8,000 ($20,000 – $12,000), the gain on the sale is $7,000 ($15,000 – $8,000). The entire gain of $7,000 is then taxed as ordinary income.
Final Thoughts
Depreciation recapture is just one piece of the complex puzzle of business asset sales and acquisitions. Do not hesitate to reach out to your KT Tax Advisor who can assist with your business planning.
