On the sale or disposition of an asset at a gain, depreciation already availed of on the same is recaptured and taken as ordinary income. The taxpayer has already deducted depreciation allowance for all his personal assets from his ordinary income. However, such properties are subject to depreciation recapture on their sale or disposition.
On the sale or disposition of an asset at a gain, depreciation already availed of on the same is recaptured and taken as ordinary income. Moreover, remaining portion of the profit element on sale of the asset over and above the aggregate depreciation enjoyed is taxed at preferential rate as capital gain.
There is another way of looking at this same thing above. Gain is the excess of sale price over the written down value of the asset, after depreciation allowances. Out of the gain, the difference between the cost of the asset and the written down value that represents the aggregate depreciation allowance already enjoyed is taxed at higher rate as ordinary income. Further, remaining part of the gain being the excess of the sale price over the cost of the asset is capital gain taxable at preferential rates.
For instance, the asset has an original basis or cost of $ 1,00,0000. Till the end of 3 years the aggregate depreciation that has been availed of is $ 25,000. So the written down value of the asset after depreciation is $ (1, 00,000-25,000) = $75,000. Now, if the taxpayer sells the asset at a sale price of $ 1, 30,000; his total gain is $ (1, 30,000-75,000) = $ 55,000. Out of the said gain $ 30,000 being the excess sale price over the cost of the asset is taxable as capital gains at lower rate. The rest being the difference of $ 25,000 between the cost of the asset and it’s written down value representing availed of depreciation recaptured is chargeable at higher rate as ordinary income.
Though real property is not liable to depreciation recapture, yet gains on sale of such real property that have enjoyed depreciation allowance is taxed at the rate of 25%. This rate is substantially higher than the tax rate on capital gains. This higher rate serves as an indirect method of depreciation recapture.
(More:http://en.wikipedia.org/wiki/Depreciation_recapture)
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