What is Depreciation Recapture?

Depreciation recapture is the difference between the tax basis of an asset and its sale price, when the sale price exceeds the tax basis. This gain must be reported as ordinary income, since the depreciation originally taken on the asset provided the taxpayer with a reduction of its ordinary income. Depreciation is used to charge the cost of an asset to expense over its useful life. If the gain exceeds the original amount of the depreciation, the excess amount may be treated as a capital gain.

The Reason for Depreciation Recapture

For a tax return, depreciation expense reduces the ordinary income paid by a business or individual, while also reducing the adjusted cost basis of the asset in question. If the asset is then dispositioned or sold at a gain, then the ordinary income tax rate is applied to the depreciation expense previously charged against the asset.

Example of Depreciation Recapture

ABC Industrial buys equipment for $20,000, which ABC then depreciates over the following four years at the rate of $2,000 per year, resulting in a net book value of $12,000. ABC then sells the equipment for $13,000. Since the sale price exceeds the net book value by $1,000, this difference is treated as depreciation recapture.