Depreciation recapture, explained
Depreciation lowers your taxes while you own something. When you sell it, the IRS takes some of that back. That's depreciation recapture — and it's why a big first-year write-off moves tax to later more than it removes it. Here's how it works and what it costs.
What depreciation recapture is
Each year you depreciate something, its tax basis — what you're treated as having paid for it — goes down by the depreciation. Sell it for more than that reduced basis and you have a gain. The part of the gain that comes from the depreciation you took is "recaptured": taxed in a way that claws back the deduction, not at the lower capital gains rates the rest of the gain can get.
How it's taxed
| Property | The depreciation part of the gain | Any gain above that |
|---|---|---|
| Equipment, vehicles, furniture, computers | Ordinary income, at your regular rate | Long-term capital gain (0, 15 or 20%) |
| Buildings — rental property, commercial property, a home office in a home you own | Taxed at your regular rate, but no more than 25% | Long-term capital gain |
For equipment, the gain above the depreciation is rare — most equipment sells for less than it cost — so in practice nearly the whole gain on a vehicle or machine is ordinary income.
Working it out
- Adjusted basis = what you paid, less the depreciation.
- Gain = the sale price, less the adjusted basis.
- Recapture = the smaller of the gain or the depreciation.
- Anything left over is capital gain. A sale below the adjusted basis is a loss instead.
A worked example: a $60,000 truck, $48,000 depreciated, sold for $35,000. The adjusted basis is $12,000, the gain $23,000 — all of it less than the $48,000 of depreciation, so all $23,000 is ordinary income.
"Allowed or allowable": depreciation you didn't take still counts
Basis goes down by the depreciation you were entitled to, whether or not you claimed it. So skipping depreciation doesn't avoid recapture — it just means you paid more tax along the way and still owe the recapture at the end. If you've missed depreciation in past years, there's a procedure to catch it up; it's worth doing before a sale.
Where it catches business owners
- A vehicle written off in year one. Sell it later and most of the price comes back as ordinary income. How vehicle write-offs work.
- Business use falls to 50% or less. Section 179 or bonus depreciation on a vehicle is partly added back to income in that year, even without a sale.
- A home office in a home you own. The depreciation isn't covered by the home-sale exclusion; it's taxed at up to 25% when you sell. More on the home office.
- Rental property. Years of depreciation on the building come due at up to 25% when it's sold.
Ways to plan for it
- A like-kind exchange. Swapping one investment or business real estate property for another can defer the gain, recapture included. It's for real property only.
- Holding until death. Heirs get a new basis, and the recapture is gone.
- An installment sale won't spread it. Recapture is taxed in the year of sale, even if the price is paid over years.
- Timing. A sale in a lower-income year is taxed at lower rates.
Sales are reported on Form 4797. How recapture affects a sale you're planning is a question for your CPA or tax attorney before you sign.
Sources
- IRC §1245 — recapture on equipment and other personal property, and its exceptions
- IRS Topic 409 — capital gains rates, and the 25% rate on unrecaptured §1250 gain
- IRC §1016(a)(2) — basis reduced by depreciation allowed or allowable
- IRC §121(d)(6) — home office depreciation and the home-sale exclusion
- IRC §453(i) and §1031 — installment sales and like-kind exchanges
- IRS Form 4797 — sales of business property
General information, not advice for your situation. Whether a strategy fits depends on your facts — talk to your CPA or tax attorney about whether you qualify before you put it in place. Your accountant remains responsible for your return.
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