44.1 Depreciation Recaptured as Ordinary Income on Sale of Personal Property

On Form 4797, you report gain or loss on the sale of depreciable property. Gain realized on the sale of depreciable personal property (Section 1245 property) is treated as ordinary income to the extent the gain is attributed to depreciation deductions that reduced basis. In other words, the depreciation deductions are “recaptured” as ordinary income. If gain exceeds the amount of depreciation subject to recapture, the excess may be capital gain under Section 1231 (44.8).

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Dispositions Other Than Sales
Recapture rules affect gifts, charitable donations, and inheritances of depreciable property (44.4), as well as like-kind exchanges and involuntary conversions (44.5).
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Gain on the sale of real estate placed in service before 1987 may be subject to depreciation recapture (44.2).

Gain subject to recapture for Section 1245 property is limited to the lower of (1) the amount of gain on the sale (amount realized less adjusted basis) or (2) the depreciation allowed or allowable while you held the property. Generally, the depreciation deduction taken into account for each year is the amount allowed or allowable, whichever is greater. However, for purposes of figuring what portion of the gain is treated as ordinary income under the recapture rules (but not for purposes of figuring gain or loss), the depreciation taken into account for any year will be the amount actually “allowed” on your prior returns under a proper depreciation method, rather than the amount “allowable,” if the allowed deduction is smaller and you can prove its amount.

The adjusted basis of personal property depreciable under ACRS, such as business equipment and machinery, is fixed as of the beginning of the year of disposition. However, property depreciated under MACRS is subject to the convention rules so that partial depreciation under the applicable convention is allowed in the year of sale; this year of sale depreciation reduces adjusted basis.

EXAMPLE
In March 2010, you bought and placed in service a light truck (five-year property) at a cost of $10,000. You used the truck 100% for business. You deducted depreciation under the half-year convention of $2,000 for 2010 and $3,200 for 2011; see the MACRS rates in 42.5. In January 2012, you sold the truck for $6,000. For 2012, you are allowed an MACRS deduction of one-half of the full year deduction, or $960 (19.20% x $10,000 ÷ 2). Your adjusted basis is $3,840 ($10,000 cost − $6,160 total depreciation). Your gain on the sale is $2,160 ($6,000 proceeds − $3,840 adjusted basis). You must recapture the entire $2,160 gain as ordinary income, as it is less than the $6,160 depreciation.
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