Federal tax code directs that if claimed as a business deduction, the value of an asset contributing to the generation of business income must be depreciated over time. Depreciation begins when the asset is first put into service for business use and ends when the original property cost has been fully recovered or when the asset is retired from service. If the asset is sold for a price larger than the amount of depreciation taken, the difference, called depreciation recapture, must be reported as either ordinary income or as a capital gain. However, there are some legal methods that allow a depreciated asset to be retired or exchanged without tax penalty.
Calculate the book value of the asset, which is the determined by subtracting the asset’s accumulated depreciation from the asset’s original cost. For example, if a computer had an original cost of $1,000 and a total of $200 has been taken as depreciation, the book value would be $800.
Avoid depreciation recapture by selling the asset for a price that is below the book value. For example, selling a computer with a book value of $800 for $799 or lower results in no profit being realized, which eliminates any depreciation recapture.
Exchange the asset for another similar asset. Called a “like-kind” exchange, this method allows the old asset to be traded, with the newly acquired property then put into service to replace the old asset. Because no gain is realized during the exchange, depreciation recapture is not triggered.
- Review IRS guidelines at IRS.gov or at a library each year to keep up with current codes related to depreciation recapture as laws may change.
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