Tuesday, January 11, 2011

Depreciation recapture

Q.  I recently read an article about depreciation recapture. What is this? GN, Arkansas

A.  First, it helps to remember that income tax rates come in two flavors: Capital gains, and Ordinary gains. Capital gains have most favorable tax treatment, at the lowest rates. With that understood, depreciation recapture is the term used to recapture depreciation previously taken on an asset when the asset is disposed. Let's say you sold your RV for a total gain of $10,000.  Over the years, you took, as an ordinary expense, depreciation of $2,000.  Since assets held more than 1 year are considered to be a Capital asset, you would pay whatever the capital gain rate is in the year of disposal. However, because over the years you wrote off $2,000 at ordinary rates, you now must recapture the depreciation at ordinary rates. In this over-simplified example, since the total gain was $10,000, you would report a capital gain of $8,000 and an ordinary gain of $2,000. In real life and the current economy, the chance of having any type of gain on the disposal of an RV would be remote at best.

PS. Since my previous answer, depreciation is no longer allowed for RVs. See Jackson, T.C. Memo 2014-160, August 7, 2014.

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