Business Tax Preparation · Analysis of financial records

Depreciation recovery (e.g., recapture, IRC Section 280F)

Depreciation is a loan against the sale price. Every dollar reduces basis, and reduced basis means more gain later — usually gain taxed at ordinary rates rather than capital ones. What makes the topic difficult is that the loan is called in at three different moments by three different mechanisms, and only one of them is a sale.

The rule

The basis falls whether you took the deduction or not. basis is reduced by depreciation allowed, but not below the amount allowable — so a taxpayer who claimed less than it could have still loses the basis, and where no method was adopted the allowable amount is determined under the straight line method^TY2026 (IRC § 1016(a)(2)). This is the proposition everything else rests on. A taxpayer who forgot to depreciate an asset does not have a higher basis on sale; it has the same basis and a lost deduction.

Recapture on sale, personal property. on a disposition of IRC § 1245 property, the excess of the lower of recomputed basis or the amount realised (or fair market value on a disposition that is not a sale) over adjusted basis is ordinary income, recognised notwithstanding any other provision of the subtitle^TY2026 (IRC § 1245(a)(1)), computed against recomputed basis: recomputed basis is adjusted basis plus all adjustments reflected in it on account of depreciation or amortization allowed or allowable — to the taxpayer or to any other person — though a taxpayer able to establish by adequate records that less was allowed than allowable adds only the amount allowed^TY2026 (IRC § 1245(a)(2)). Note both extensions there — allowed or allowable, and allowed to the taxpayer or to any other person, which is how recapture follows property through a carryover-basis transfer. property which is or has been of a character subject to the allowance for depreciation and is either personal property, or other tangible property, not including a building or its structural components, used as an integral part of manufacturing, production or extraction or of furnishing transportation, communications, utilities or sewage services, or as a research or bulk storage facility connected with those activities^TY2026 (IRC § 1245(a)(3)).

Recapture on sale, real property. on a disposition of IRC § 1250 property, the applicable percentage of the lower of the additional depreciation attributable to periods after 31 December 1975 or the excess of the amount realised over adjusted basis is ordinary income^TY2026 (IRC § 1250(a)(1)). Real property has been on straight-line recovery since 1986, so additional depreciation is usually nil and § 1250 recaptures nothing — but the gain does not become ordinary capital gain either: the long-term capital gain that would have been ordinary income if IRC § 1250(b)(1) included all depreciation and the IRC § 1250(a) applicable percentage were 100 percent — taxed at its own rate rather than the ordinary rate or the general capital gains rate^TY2026 (IRC § 1(h)(6)).

What is left goes to section 1231. property used in the trade or business of a character subject to the allowance for depreciation, and real property used in the trade or business, in each case held for more than 1 year — excluding inventory, property held primarily for sale to customers, self-created intangibles of the kind described in IRC § 1221(a)(3), and certain government publications^TY2026 (IRC § 1231(b)(1)), where the IRC § 1231 gains for the year exceed the IRC § 1231 losses, all of them are treated as long-term capital gains and losses; where they do not, all are treated as ordinary^TY2026 (IRC § 1231(a)(1)), subject to net IRC § 1231 gain is treated as ordinary income to the extent of the non-recaptured net IRC § 1231 losses — the aggregate net losses of the 5 most recent preceding taxable years, less any already recaptured^TY2026 (IRC § 1231(c)(1)).

Recapture without a sale, listed property. listed property means any passenger automobile, any other property used as a means of transportation, any property of a type generally used for entertainment, recreation or amusement, and anything else the Secretary specifies — with an exception for transportation property substantially all of whose use is in a business of transporting persons or property for hire for unrelated persons^TY2026 (IRC § 280F(d)(4)); the narrower category is a passenger automobile is any four-wheeled vehicle manufactured primarily for use on public streets, roads and highways and rated at 6,000 pounds unloaded gross vehicle weight or less^TY2026 (IRC § 280F(d)(5)(A)). The test that matters is qualified business use means any use in a trade or business, but excludes leasing property to a 5-percent owner or related person, use provided as compensation to such a person, and use provided as compensation to anyone else unless an amount is included in that person’s gross income and, where required, withheld on^TY2026 (IRC § 280F(d)(6)). Fall below the line and two things happen at once: {fig:vehicle.280F_fifty_percent} (IRC § 280F(b)(1)) and {fig:vehicle.280F_recapture} (IRC § 280F(b)(2)(A)), the amount being excess depreciation is the depreciation allowable for the years before the first year of non-predominant business use, over what would have been allowable had the property not been predominantly used in a qualified business use in the year it was placed in service^TY2026.

Recapture without a sale, expensing. where IRC § 179 property ceases to be used predominantly in a trade or business before the end of its recovery period, the benefit of expensing is recaptured in that year — the excess of the amount expensed over what IRC § 168 would have allowed for the prior years and the year of recapture had the election not been made, whether or not that excess actually reduced tax^TY2026 (Reg. § 1.179-1(e)(1); IRC § 179(d)(10)).

And the annual ceiling on an automobile. {fig:vehicle.280F_bonus_2026} (Rev. Proc. 2026-15 Table 1); where no IRC § 168(k) deduction applies, {fig:vehicle.280F_nobonus_2026} (Table 2). {fig:vehicle.280F_unrecovered} (IRC § 280F(a)(1)(B)).

Current figures

How it works in practice

Recapture is a character rule, not an amount rule. It never creates gain — it takes gain that already exists and reclassifies it from capital to ordinary, up to the depreciation taken. That is why an asset sold at a loss produces no recapture however much depreciation it absorbed, and why an asset sold above original cost recaptures only up to the depreciation, the excess running to § 1231.

Work a disposition in a fixed order. Amount realised; adjusted basis, reduced by depreciation allowed but not below the allowable floor; the difference. A loss stops there — § 1231 loss, ordinary. A gain goes on: convert to ordinary income, under § 1245 or § 1250, as much as the depreciation taken. Anything above that is § 1231 gain, which nets with the year’s other § 1231 items and is recharacterised as ordinary to the extent of non-recaptured net § 1231 losses of the previous five years.

Section 1245 and section 1250 recapture different things. Section 1245 recaptures all depreciation, so on personal property the entire deduction comes back as ordinary income to the extent of gain. Section 1250 recaptures only additional depreciation — the excess over straight line — which for property placed in service after 1986 is normally zero. So a building sold at a gain generates no § 1250 recapture and a large unrecaptured § 1250 gain instead, taxed at its own rate.

The listed property rules bite before any sale. The § 280F(b) mechanism is the one candidates most often miss, because nothing is disposed of. A vehicle that went into service well above the line and drops below it in year three obliges the taxpayer to include the excess depreciation in income in year three and to switch to the alternative depreciation system for that year and all later ones. The comparison is against what the alternative system would have allowed from the start, not against zero.

The 5-percent owner exception makes use look worse than it is. Qualified business use excludes use leased to a 5-percent owner or provided as compensation to one, unless the value is included in that person’s income and withheld on. So an owner-manager driving a company car is not generating qualified business use for the predominant-use test unless the personal use is run through payroll — the fact pattern that pushes a vehicle below the line without anyone noticing.

Expensing recapture is computed differently from listed property recapture. Reg. § 1.179-1(e)(1) compares what was expensed against what § 168 would have allowed had the election never been made — through the year of recapture, not just the prior years. And it applies whether or not the deduction actually reduced tax, so a taxpayer with losses in the year of the election still recaptures in full.

Read all of this off the balance sheet before it is a problem. Accumulated depreciation, the depreciation schedule and the asset accounts together show which assets carry a large ordinary income exposure on sale, which listed property is drifting toward the line, and whether last year’s disposals had their gain computed at all.

Scenarios

Traps

How this has changed

The most consequential recent movement is not in the recapture provisions, which have been stable, but in how much there is to recapture. Pub. L. 119-21 § 70301 made the IRC § 168(k) additional first year depreciation permanent at the full statutory rate and repealed the phase-down, so an asset acquired and placed in service after 19 January 2025 typically carries a basis of zero from its first year. Every dollar of a later sale price is therefore gain, and on § 1245 property every dollar up to original cost is ordinary income. The recapture rules did not change; the exposure they create grew.

The interaction is visible on the automobile side. Rev. Proc. 2026-15 publishes two tables for cars placed in service in 2026 that differ only in the first year, and only by {fig:vehicle.280F_bonus_uplift} — and the revenue procedure states that Table 1 applies whether the § 168(k) deduction comes from the amended provision or from former § 168(k), whose applicable percentage for property acquired before 20 January 2025 has phased down. Two statutory routes, one table.

Section 1250 has been quietly emptying since 1986, when the Tax Reform Act put real property on straight-line recovery. Additional depreciation can now arise only on property placed in service before that change or on the narrow categories still eligible for accelerated methods, so the practical question on almost every building is unrecaptured section 1250 gain rather than § 1250 recapture.

Nothing in the post-2024 legislation alters IRC § 280F(b), IRC § 1016(a)(2) or the § 1245 mechanics.

Exam focus

Start every disposition question with IRC § 1016(a)(2). The allowed-or-allowable rule is the most productive proposition here and appears constantly as a fact pattern in which the taxpayer under-claimed or forgot to claim.

Know the order: amount realised, adjusted basis, gain or loss, recapture, § 1231 — and that recapture is capped by gain and never creates it.

Keep § 1245 and § 1250 apart by what each recaptures — all depreciation against additional depreciation — and keep unrecaptured section 1250 gain apart from both. Expect a question that offers § 1250 recapture as a distractor on straight-line property.

For § 280F, memorise the three tests as a sequence: is it listed property, is it a passenger automobile, and is more than half the use qualified business use. Be ready to explain that falling below the line does two things at once — ADS prospectively and excess depreciation into income now — and that excess depreciation is measured against the ADS amount, not against zero.

Finally, distinguish the two non-sale recaptures. Section 280F(b) applies to listed property on the predominant-use cliff; Reg. § 1.179-1(e) applies to expensed property, computes its amount differently, and operates whether or not the original deduction saved any tax.

Check yourself

1. A machine costing $120,000 has accumulated depreciation of $85,000 and is sold for $150,000. How is the gain characterised?

Answer: Adjusted basis is $35,000, so the gain is $115,000. IRC § 1245(a)(1) makes ordinary the excess of the lower of recomputed basis ($120,000) or amount realised ($150,000) over adjusted basis — $120,000 less $35,000, giving $85,000 of ordinary income, exactly the depreciation taken. The remaining $30,000 is gain above original cost, which § 1245 does not reach: IRC § 1231 gain, netting with the year’s other § 1231 items subject to the five-year lookback.

2. A sole proprietor never depreciated a $40,000 trailer used in the business for six years, and sells it for $18,000. Is there a loss?

Answer: Almost certainly not. IRC § 1016(a)(2) reduces basis by depreciation allowed but not below the amount allowable, so the trailer’s basis has fallen by the MACRS depreciation that could have been claimed regardless of the failure to claim it. Over six years on a five-year recovery period that is the whole cost, leaving a basis near zero and a gain near $18,000. IRC § 1245(a)(2)(B) lets the proprietor add back only what was actually allowed, if it can establish that by adequate records — limiting recomputed basis and hence the ordinary income. The basis reduction itself is not undone.

3. A car is placed in service at 65 percent business use, of which 20 points consist of use by a 5-percent owner as compensation with no amount included in her income. Does the car qualify for MACRS in year one?

Answer: No. IRC § 280F(d)(6)(C) excludes from qualified business use any use of property provided as compensation for services by a 5-percent owner unless an amount is included in that person’s gross income and, where required, withheld on. Stripping out those 20 points leaves qualified business use below the halfway mark, so IRC § 280F(b)(1) puts the car on the alternative depreciation system from year one. There is no excess depreciation to recapture: § 280F(b)(2)(A) requires as its first condition that the property was predominantly used in a qualified business use in the year it was placed in service, and it never was.

4. A warehouse placed in service in 2012 and depreciated straight line is sold at a $500,000 gain, with $210,000 of accumulated depreciation. How much is recaptured under IRC § 1250?

Answer: None. Section 1250 recaptures the applicable percentage of additional depreciation, meaning the excess of depreciation taken over straight line, and a taxpayer that used straight line has no additional depreciation. But the answer does not end there: $210,000 is unrecaptured section 1250 gain under IRC § 1(h)(6), long-term capital gain taxed at its own rate, and the remaining $290,000 is § 1231 gain. A response of “no recapture, all capital gain at the ordinary long-term rate” is the mistake the question is testing for.

5. Why does IRC § 1245(a)(2)(A) add back depreciation allowed to any other person?

Answer: To stop recapture being washed out by a carryover-basis transfer. Where a taxpayer takes property with a basis determined by reference to the transferor’s — a gift, a contribution to a controlled corporation, a like-kind exchange — the recapture potential built up in the transferor’s hands would otherwise disappear, since the transferee took none of that depreciation itself. Adding back depreciation allowed or allowable to any other person makes recapture follow the property, which is why a question can turn on the history of an asset the current owner never depreciated.