What is Depreciation Recapture?

Depreciation deductions reduce an asset's tax basis. When the asset is sold for more than its reduced basis, part or all of the gain reflects the depreciation previously deducted. Tax rules "recapture" that portion, generally as ordinary income.

Personal property (Section 1245)

For equipment, vehicles, furniture and similar property, gain up to the total depreciation taken, including Section 179 and bonus depreciation, is generally ordinary income. Only gain above the original cost may qualify for capital gain treatment.

Real property (Section 1250)

Buildings depreciated under straight-line methods generally have limited ordinary recapture, but individuals may pay tax on "unrecaptured Section 1250 gain" at a special maximum rate. The IRS describes recapture in Publication 544 and the Instructions for Form 4797.

Example

A business buys a $40,000 machine, deducts it fully under Section 179, then sells it two years later for $25,000. Basis is zero, so gain is $25,000, all of which is recaptured as ordinary income because it does not exceed the $40,000 of depreciation.

Business use falling below 50%

For listed property such as vehicles, if business use drops to 50% or less, some previously claimed Section 179 or accelerated depreciation may be recaptured even without a sale.

Why it matters

Large upfront deductions are valuable, but they can produce ordinary income later. Consider recapture when deciding whether to expense or depreciate and when planning asset sales or trade-ins.

See accumulated depreciation, capital gains and the fixed asset register.

Related terms

• Accumulated Depreciation: Accumulated depreciation is the total depreciation recorded on an asset since it was placed in service.
• Tax Basis: Tax basis is the amount the tax law treats as your investment in property, used to figure depreciation and gain or loss.
• Ordinary and Necessary Expenses: Ordinary and necessary is the basic test a business expense must meet to be deductible.
• Capital Gains: A capital gain is the profit from selling a capital asset for more than its tax basis.

Browse more definitions in the small business glossary.