What Is Accelerated Depreciation Recapture?
Accelerated depreciation recapture is a tax rule requiring taxpayers to pay back some of the benefits received from accelerated depreciation when an asset has been sold. If an asset is sold for more than depreciated value, the IRS classifies part of the gain as ordinary income so that January 1, (2013) they get to take some tax benefit for faster depreciation, and then April 15 (2014) they pay ordinary income taxes on at least a portion of their gain.
How Does Accelerated Depreciation Recapture Work?
- Determine Adjusted Basis: Subtract total depreciation from the original cost of the asset.
- Gain Calculation: Take the sales price and subtract your adjusted basis.
- Identify Recapture Amount: Depreciation gain is taxed as ordinary income, and remaining gain is capital gain.
What Types of Depreciation Are Subject to Recapture?
These are the different types of depreciation that you will typically lead to recapture:
- Accelerated Depreciation: Assets depreciated at a faster rate with the straight line method.
- Bonus Decreasing: Business Properties: Businesses that have deductions for assets using bonus depreciation will often see recapture.
- Section 179 Deductions: Lastly, assets you expensed under Section 179 lose their tax way and must also be recaptured on sale.
- For example:
- Purchased Equipment: $100,000
- Depreciation Taken: $70,000
- Basis adjusted: $30K ($100K – $70K)
- Sale Price: $90,000
- Capital Gain: $60,000 ($90,000 – $30,000)
- Depreciation Recapture: $60,000 (ordinary income treatment up to depreciation)
Key Facts About Accelerated Depreciation Recapture
- Taxes: Depreciation recapture gets taxed at the ordinary income rate, which is often higher than the tax rate on capital gains.
- Qualifying Property: Used for property such as depreciable assets (buildings, equipment, and vehicles)
- Real Estate: For real estate (Section 1250 property), the recapture rate is generally 25% for gains attributable to depreciation in excess of the straight-line method for residential properties.
Tax Implications of Accelerated Depreciation Recapture
|
Aspect |
Details |
|
Higher Tax Rate |
In regard to depreciation recapture, higher Tax Rate Gains are taxed as ordinary income up to 37%. |
|
Real Estate |
For real estate, unrecaptured Section 1250 gains are limited to a maximum tax rate of 25% if the property was depreciated using straight line depreciation. |
|
State Taxes |
Depending on where the property sits, state taxes may also be imposed. |
|
Cash Flow Considerations |
Proper planning will ensure cash flow and avoid surprises when the tax is due. |
Tips to Manage Accelerated Depreciation Recapture
- 1031 Exchange: Rather than recapture, reinvest the proceeds from the sale into another similar property.
- Installment Sale: Spreads the tax liability over a number of years.
- Consult a CPA: Professional guidance helps minimize tax impact and ensure compliance.
Common Mistakes to Avoid
- Recapture Misunderstanding: Recapture is handled differently than a capital gain.
- Adjusted Basis: An incorrect basis can lead to tax reporting errors.
- Inadequate preparation: Planning ahead is important so you stay one step ahead of depreciation recapture.
Our Services
Dimov CPA provides several services in managing accelerated depreciation recapture and IRS compliance:
- Depreciation Recapture Analysis: We calculate depreciation recapture and estimate potential tax liability to avoid surprises.
- Asset Sales: Help with planning asset sales, such as 1031 exchanges or installment sales to reduce taxation.
- 1031 Exchange Guidance: Expert assistance in performing 1031 exchanges.
- State Tax Compliance: State Law review to confirm compliance.
- IRS Filing Assistance: Guidance to ensure you report any depreciation recapture on IRS Form 4797 properly and reduce your chance of making a mistake or incurring penalties.
- Expert Guidance: How to use depreciation and recapture as part of your success story.
Conclusion
The significance of accelerated depreciation recapture in tax planning for selling an asset that has been depreciated cannot be understated, as it effectively reconciles the benefit received from prior periods with a current obligation to pay taxes. However, with good planning and correct reporting on IRS Form 4797, recapture tax can be gratefully managed too — especially if you like speaking with a professional company such as Dimov CPA.
FAQs
What is accelerated depreciation recapture?
Accelerated depreciation recapture taxes gains on sold assets that benefited from accelerated depreciation as ordinary income and therefore recover previous tax benefits.
How is depreciation recapture determined?
It is calculated as sale price less adjusted basis (original cost, or purchase price, minus any depreciation). Appreciation is subject to depreciation recapture as ordinary income.
What can I do to minimize depreciation recapture?
Use a 1031 exchange or installment sale defer or spread out tax liability Speaking to a CPA is also advised.
Which assets are subject to depreciation recapture?
In broad terms, this means that if you took a bonus or large depreciation deduction on your tax return for the item in past years, it is likely going to be subject to recapture when you sell.113 For example, building and equipment and vehicles that have been used for business purposes are usually subject to recapture.
What if I don’t pay depreciation recapture?
Not paying could result in penalties, interest, and other legal action by the IRS. This is why correct continuing reporting and obligation assists avoid the above consequences.
Do I get to offset depreciation recapture with losses?
Taxable losses, from other investments, can offset recapture gains. Do speak to a tax professional about this, though, to ensure you meet the criteria.
