The Recapture

Sometimes when an individual person is in business some machinery and/or equipment gets used up, old, and even worn out, and may decide to sell the old machinery and/or equipment, so the individual business owner could raise funds to purchase freshly new machinery and/or equipment.  Of course, one has to consider the tax consequences of selling such machinery and/or equipment.

First consideration is that has time marches on (especially over the years), as machinery and/or equipment gets used up, old, and even worn out, there is an accounting for depreciation to reflect the use of such machinery and/or equipment, which produces a “net asset value” or adjusted basis on such machinery and/or equipment, this figure is very important because a person or entity) is taxed on the gain, and NOT on the selling price of the sale of the asset, and gain is determined by the selling price minus the adjusted basis.  Furthermore, adjusted basis is determined by taking the original purchase costs (or purchasing price), and subtract deprecation.

For example, and individual business owner purchases some business machinery and/or equipment for $4,000 and over the years $500 depreciation was claimed for the use, wear, and tear of such machinery and/or equipment.  Thusly, the adjusted basis on the machinery and/or equipment is $3,500 ($4,000 minus $3,500).   Now, if the machinery and/or equipment were sold for $5,000, then the gain would be $1,500 ($5,000 was the selling price minus $3,500 adjusted basis).

The next consideration is what type of tax rate does is the gain shall be taxed on, because in the federal tax code there are two types of individual tax rates, ordinary income tax rates (which for 2015 10%, 15%, 28%, 33%, 35%, and 39.6%), and the favorable capital gain rates (for 2015, the maximum capital gains rate is generally 20%).  Gain on most business machinery/equipment, sold by an individual business owner, would be taxed on his/her favorable capital gain rates.  However, the problem becomes with deprecation, because any gain related from deprecation must be “recaptured” and taxed on an individual’s higher ordinary income tax rates.  So, taking our example further, where some business machinery and/or equipment were sold at a gain of $1,500, $500 worth of deprecation was claimed.  Thereby out of the $1,500 gain, $500 would be “recaptured deprecation” and taxed at an individual’s higher ordinary income tax rates, and the remaining $1,000 would be at the favorable capital gains rate.

So, if you are an individual business owner, and you are considering selling of your old business machinery/equipment, contact us , and we would more than happy to figure the deprecation of the old machinery/equipment, and see if any of this “depreciation recapture” would apply.