Depreciation Recapture: What Happens When Business Property Is Sold

Depreciation reduces an asset's adjusted tax basis. When depreciated business property is sold or otherwise disposed of, the difference between the amount realized and adjusted basis may not receive one uniform capital-gain rate. The result depends on the type of property, depreciation method, holding period, entity, and transaction structure.

Section 1245 Property

Machinery, equipment, vehicles, furniture, certain building components, and many amortizable intangibles may be Section 1245 property. Gain generally is treated as ordinary income to the extent of depreciation or amortization allowed or allowable, limited by the gain realized. Section 179 deductions and bonus depreciation generally increase the potential ordinary-income recapture because they reduce basis quickly.

Depreciable Real Property and Section 1250

For most post-1986 depreciable real property using straight-line depreciation, Section 1250 ordinary-income recapture often is limited or zero. Individuals may nevertheless have unrecaptured Section 1250 gain attributable to depreciation, taxed at a maximum 25% federal rate. Corporations can face additional Section 291 ordinary-income treatment. Land is not depreciable and should be allocated separately.

Section 1231 Can Affect the Remaining Gain or Loss

After applicable recapture, remaining gain or loss on qualifying business property held more than one year may enter the Section 1231 netting process. Net Section 1231 gain may receive long-term capital-gain treatment, while a net loss may be ordinary. The five-year lookback rule can recharacterize current net gain as ordinary to the extent of prior nonrecaptured Section 1231 losses.

Installment Sales Do Not Necessarily Defer Recapture

In an installment sale, depreciation-recapture income generally is recognized in the year of sale even when cash will be collected later. The remaining eligible gain may be reported under the installment method. Related-party sales, dealer property, publicly traded property, debt assumptions, and depreciation recapture can limit or change installment reporting.

Allocation and Records Drive the Calculation

Keep purchase documents, placed-in-service dates, improvement records, depreciation schedules, Section 179 and bonus elections, prior casualty or exchange adjustments, and sale documents. When multiple assets are sold together, the purchase-price allocation can affect ordinary income, capital gain, inventory income, goodwill, and buyer basis. Buyer and seller reporting should be consistent when Form 8594 applies.

This article provides general federal tax information. A disposition may also involve passive losses, at-risk rules, built-in gains tax, partnership hot assets, state tax, or prior Section 1031 deferral.

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