Depreciation Recapture on a Commercial Property

Depreciation recapture on a commercial property occurs when the property is sold at a gain. As a portion of this increase is partially attributable to depreciation deductions taken in prior years, the increase will be taxed as a capital gain.

How is Depreciation Recaptured?

Current law requires owners of commercial property purchased after 1993 to deduct 1/39th of the original cost each year. The depreciation results in a reduced adjusted tax basis. The resulting gain is the difference between the selling price and the adjusted tax basis. If the property is sold, that profit will be seen as capital gain and will be taxed accordingly. This taxation "recaptures" the gains the owner received due to the tax adjustments. For property sold on or before May 7, 1997, the capital gain is taxed at a rate of 28%; for property sold after this date, the recapture is at a 25% rate.
When Must Depreciation be Recaptured?

When you dispose of property depreciated using the Modified Accelerated Cost Recovery System (MACRS), the gain upon sale must be recaptured as ordinary income up to the previously allowable depreciation amount. This applies to any deduction taken under Section 179 (which allows businesses to deduct the full purchase price of any business equipment) or any depreciation allowance for a Liberty Zone property (an allowance established after the 9/11 terrorist attacks).

To estimate depreciation and calculate gain reportable as ordinary income, the owner should keep records that include the date and circumstances of the acquisition, the cost, and other adjustments that may affect the tax basis.

Even if owners try to avoid the recapture tax, they are subject to taxation on any appreciation that is "allowable." In other words, they will still have to pay whether they took the deduction or not.

Like-Kind Exchanges

A gain from a like-kind exchange or an involuntary conversion of depreciable real property is not reportable income if the gain is carried over to the depreciable real property acquired in the like-kind exchange.

On property acquired in a nontaxable exchange or as a gift, records also must indicate the following information:

  • whether the adjusted basis was figured using depreciation or amortization the owner claimed on other property; or
  • whether the adjusted basis was figured using depreciation or amortization another person claimed.

Talk With an Attorney

Depreciation recapture on a commercial property is a complicated matter that is subject to error and miscalculations. Discuss any taxation issue with a certified accountant as well as a tax attorney to ensure any sales or transfers comply with current tax laws.

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