Depreciation recapture is the USA Internal Revenue Service (

IRS The Internal Revenue Service (IRS) is the revenue service for the United States federal government, which is responsible for collecting U.S. federal taxes and administering the Internal Revenue Code, the main body of the federal statutory tax ...

) procedure for collecting income tax on a gain realized by a taxpayer when the taxpayer disposes of an asset that had previously provided an offset to ordinary income for the taxpayer through

depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the a ...

. In other words, because the IRS allows a taxpayer to deduct the depreciation of an asset from the taxpayer's ordinary income, the taxpayer has to report any gain from the disposal of the asset (up to the recomputed basis) as ordinary income, not as a

capital gain Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares ...

. Depreciation recapture most commonly applies when dealing with the sale of improved

real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...

(such as rental property), as the value of real estate generally increases over time while the improvements are subject to depreciation. Depreciation recapture in the USA is governed by sections 1245 and 1250 of the

Internal Revenue Code The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 2 ...

(IRC). Any gain over the recomputed basis will be taxed as a capital gain in accordance with section 1231 of the IRC. This article is about the system used in the US and Canada, but other countries have similar procedures. In the UK,

HMRC HM Revenue and Customs (His Majesty's Revenue and Customs, or HMRC) is a non-ministerial government department, non-ministerial Departments of the United Kingdom Government, department of the His Majesty's Government, UK Government responsible fo ...

uses "negative depreciation".

Basis

The starting point for determining when a depreciation recaptu