How Depreciation Recapture Works
When you sell an asset, such as equipment or real estate, for more than its adjusted basis (the original cost minus accumulated depreciation), the IRS requires you to “recapture” the depreciation you’ve taken over the years.
This means the amount of depreciation you’ve claimed is added back into your taxable income. For example, if you deducted depreciation on a piece of machinery or property, you’ll need to pay taxes on that deducted amount when you sell it.
Tax Rates for Depreciation Recapture
The amount of depreciation recapture is taxed differently depending on the type of asset:
- Ordinary Income Tax: For most assets like machinery or business equipment, the recaptured depreciation is taxed as ordinary income.
- Special 25% Rate for Real Estate: If the asset is real estate, the recaptured depreciation is taxed at a special rate of 25%.
Example
Suppose you purchased an asset for $10,000 and claimed $4,000 in depreciation over several years. If you sell the asset for $12,000, your adjusted basis is $6,000 ($10,000 – $4,000). The $6,000 gain will be taxed, but the $4,000 depreciation will be recaptured and taxed at the applicable rate.
Final Tips
Understanding the depreciation recapture rule is essential for managing your tax liability when selling assets. Be sure to keep track of depreciation and consult with a tax professional to help navigate this complex aspect of tax law.
