Depreciation recapture

Depreciation deductions lower your ordinary income while you own business property. They also lower the property’s basis, so a later sale shows a larger gain. Recapture rules decide how much of that extra gain is taxed as ordinary income. The recapture is figured on Form 4797.

For equipment and other Section 1245 property, gain up to the depreciation allowed or allowable is ordinary income. That counts depreciation you could have claimed but did not. It also includes Section 179 deductions and bonus depreciation. For example, a $100,000 machine written off in full with bonus depreciation has a basis of $0. If it sells for $60,000, all $60,000 of gain is ordinary income. If it sells for $120,000 after more than a year, $100,000 is ordinary income and $20,000 is Section 1231 gain.

Rental and commercial buildings are Section 1250 property, and their rules are gentler. A building placed in service after 1986 and depreciated on the straight line usually has no ordinary-income recapture. For an individual owner, the gain that comes from its depreciation is unrecaptured Section 1250 gain instead. It is taxed at no more than 25%. A C corporation that sells the building generally treats 20% of that depreciation as ordinary income.

Section 179 deductions can be recaptured even without a sale. That happens when business use falls to 50% or less before the property’s recovery period ends. You then report as income the deduction minus the regular depreciation you could have taken.