Selling a truck, a piece of equipment or a building can bring in good money. But if you’ve been taking depreciation on it, part of that sale may be taxed at a higher rate than you expect. That’s called depreciation recapture, and it’s worth understanding before you sign anything.
What depreciation recapture is
Each year you depreciate an asset, you get a tax deduction. That lowers the asset’s “adjusted basis,” which is what it’s worth on your books for tax purposes.
If you later sell it for more than that adjusted basis, the IRS takes back some of those earlier tax breaks. The part of your gain that came from depreciation gets taxed as ordinary income instead of at the lower capital gains rate.
Section 1245 property: equipment, vehicles and other personal property
Section 1245 covers most business property that isn’t real estate. It has the strictest recapture rules. Common examples:
- Machinery: shop equipment, tools and specialized hardware.
- Vehicles: delivery trucks, service vans and cars used for business.
- Technology: computers, servers, other hardware and software.
- Furniture: desks, chairs, filing cabinets and fixtures.
Here’s how the recapture works:
- Figure your gain: sale price minus adjusted basis.
- Add up all the depreciation you’ve taken on the asset.
- Your recapture is whichever of those two numbers is smaller.
- That recapture amount is taxed at ordinary income rates.
Section 1250 property: buildings
Section 1250 covers real property, like buildings and their structural parts. The rules here are different from equipment.
- Buildings: offices, warehouses and retail storefronts.
- Components: HVAC, roofing, plumbing and elevators.
How the gain is taxed:
- Additional depreciation (anything taken beyond the straight-line method) is taxed as ordinary income.
- Unrecaptured gain, the part that came from straight-line depreciation, is taxed at a maximum of 25%.
- Any gain left over is taxed as a long-term capital gain.
The records you’ll need
Getting the tax right on a sale depends on records that go back to the day you bought the asset. Without them, you can end up overpaying or getting it wrong with the IRS. You’ll want:
- Original cost: what you paid, including shipping and installation.
- Accumulated depreciation: every deduction taken from the day you started using it until the sale.
- Adjusted basis: original cost minus accumulated depreciation.
- Sale proceeds: the full amount the buyer paid.
- Selling expenses: commissions, legal fees and transfer taxes.
If any of these are off, your financial statements will be off too, and you could face penalties. Good bookkeeping tracks each asset from purchase to sale so these numbers are ready when you need them.
Figuring the tax before you sell
It’s much better to know the tax bill before the sale than after. Here’s the basic process:
Step 1: Figure your total gain.
- (Sale price minus selling expenses) minus adjusted basis = total gain.
Step 2: Sort it by type of property.
- Equipment, vehicles and other personal property follow the Section 1245 rules.
- Buildings and other real property follow the Section 1250 rules.
Step 3: Apply the right rates.
- Ordinary income rates apply to Section 1245 recapture and Section 1250 additional depreciation.
- Up to 25% applies to unrecaptured Section 1250 gain (from straight-line depreciation).
- Capital gains rates apply to any gain beyond the total depreciation.
What it does to your cash
The tax from recapture is due for the year you sell, so plan for it as real cash going out.
- Higher bracket: the extra income could push you into a higher tax bracket.
- Estimated payments: a big gain may mean making a quarterly estimated payment to avoid an underpayment penalty.
- What you keep: when you look at what the sale nets you, subtract the expected tax bill.
Up-to-date books and financial statements let you estimate your year-end tax before you sell. That gives you a chance to think about timing, like whether selling this year or next makes more sense.
How I help
I’m Miles, a certified QuickBooks ProAdvisor at MilesP Bookkeeping, LLC, working with businesses in Columbia, Waterloo and Belleville, IL and St. Louis, MO. When it comes to assets, I handle:
- Monthly tracking of your assets and depreciation schedules.
- Bank reconciliations that match the money from a sale to the sale agreement.
- Financial statements, including the balance sheet and income statement your tax preparer needs.
- Recording the sale correctly under current IRS guidelines.
Quick comparison: Section 1245 vs. Section 1250
| Section 1245 | Section 1250 | |
|---|---|---|
| Type of property | Personal property | Real property |
| Tax rate on recapture | Ordinary income rate | Up to 25% (unrecaptured gain) |
| Typical assets | Equipment, vehicles | Buildings, warehouses |
| Recapture limit | Total depreciation taken | Additional depreciation |
| Reported on | Form 4797 | Form 4797 |
Before you sell
If you’re thinking about selling equipment or property, check your records first. Skipping this step is how people end up with a tax bill they didn’t see coming. Here’s what I’d do:
- Review your fixed asset list.
- Confirm which depreciation method was used (MACRS or straight-line).
- Estimate the gain on the sale you’re planning.
- Have a bookkeeper make sure the records are accurate.
Want me to look over your asset records and financial statements? Get in touch or call (800) 926-7710.