Depreciation recapture
section 1245 recapture / recapture of depreciation / ordinary income recapture
Depreciation recapture is the tax rule that treats gain on selling depreciated business equipment and other section 1245 property as ordinary income, up to the depreciation allowed or allowable. It decides how much of the money from selling equipment written off with Section 179 or bonus depreciation is taxed as ordinary income.
Depreciation recapture is the rule in IRS Publication 544 that treats part or all of a gain on selling depreciated business property as ordinary income. It generally counts depreciation that was allowable, even when none was claimed. On an installment sale, recapture is taxed in the year of sale, even with no payments that year.
Gain is the amount realized minus the adjusted basis, and depreciation lowers that basis. Depreciable personal property is section 1245 property. Its ordinary income is the lesser of the depreciation allowed or allowable and the gain realized. In the IRS example, a $10,000 truck with $6,160 of depreciation sells for $7,000, so the full $3,160 gain is ordinary income. Any gain above that part is section 1231 gain.
The depreciation counted includes ordinary deductions, any special depreciation allowance under section 168(k), often called bonus depreciation, and the section 179 deduction. If none was taken, the allowable amount is figured with the straight-line method for section 1245 recapture. Gain on property expensed under the de minimis safe harbor is generally ordinary income, reported in Part II of Form 4797.
Buildings and structural components generally fall under section 1250. Under P.L. 119-21, elected qualified production property placed in service after July 4, 2025, is section 1245 property instead. Section 1250 gain is ordinary income to the extent of additional depreciation. For property held longer than 1 year, that is depreciation above the straight-line amount. For property held 1 year or less, all depreciation counts. Corporations other than S corporations also treat 20% of the excess of section 1245 recapture over section 1250 recapture as ordinary income. Generally, the part of long-term capital gain on section 1250 property due to depreciation is unrecaptured section 1250 gain. For individuals, Topic 409 sets a maximum 25% rate on it.
Without a sale, Section 179 recapture can apply in a year of the recovery period when business use drops to 50% or less. Listed property, such as a passenger automobile, follows its own rule if business use topped 50% in the year it was placed in service. In the first year business use is 50% or less, excess depreciation is recaptured. That is the depreciation allowable for earlier years, including any section 179 deduction and special allowance, minus straight-line ADS depreciation for those years.
In practice
A roofing company buys a $40,000 skid steer and deducts the full cost under Section 179. Its adjusted basis is now zero. Three years later it sells the machine for $25,000. The gain is $25,000, and because $40,000 of depreciation was taken, all $25,000 is ordinary income, figured in Part III of Form 4797. The figures are a worked example.
Not the same as
- Section 179 recapture
- Section 179 recapture can apply without a sale, in any year of the recovery period that business use of the property drops to 50% or less, and is reported in Part IV of Form 4797. Listed property, such as passenger automobiles, uses the excess depreciation rules in chapter 5 of Publication 946 instead. Recapture on a sale is figured in Part III.
Why it matters to you
Section 179 and bonus depreciation bring the deduction into the year of purchase. Recapture can bring it back as ordinary income on a sale at a gain. For individuals, Publication 544 notes that tax rates on a net capital gain are generally lower than the rates on other income. Figuring the amount takes permanent records of the depreciation allowed or allowable.
What to ask or check
- 01How much depreciation, including Section 179 and bonus depreciation, has the business taken on this asset?
- 02What is your adjusted basis in the equipment, and how much gain would be ordinary income?
- 03If the buyer pays in installments, how much recapture income falls in the year of sale?
- 04Has business use of any Section 179 property or passenger automobile dropped to 50% or less?
What people get wrong
That selling equipment for less than its original cost produces no taxable gain. Publication 544 measures gain against adjusted basis, which depreciation reduces, and treats that gain on section 1245 property as ordinary income up to the depreciation allowed or allowable.
Red flags
- A plan to sell equipment that was written off in full, with no estimate of the tax due on the sale.