How Does Depreciation Recapture Work?
We got the following question from one of our readers:
“When does depreciation recapture on equipment kick in? For example a 20 year old tractor fully depreciated sells for $30,000 cash. It cost $50,000 new. Is any of the $30,000 considered a capital gain?”
This is a fairly common transaction for many farmers during their farm career. Let’s take the example that was part of the question and break it down.
When, the tractor is purchased for $50,000, this is the basis that is used for depreciation purposes. In this case, the tractor was fully depreciated and sold for $30,000. Depreciation is recaptured up to the amount of “total depreciation taken”. So, in this case, all of the gain is depreciation recapture since the sales price of $30,000 is less than the total depreciation of $50,000. Another way to look at it is if the the sales price is less than original cost, then all of the gain will always be depreciation recapture.
If the tractor had sold for $70,000, then there would have been depreciation recapture of $50,000 and Section 1231 gain of $20,000. This gain is usually taxed as long-term capital gains, however, if during the last five years, you had accumulated Section 1231 losses, then part of this gain would be taxed as ordinary income.
In the example, the farmer sold the tractor for cash. Let’s assume the farmer sold the tractor to a neighbor for $5,000 down and the remainder on a five year note. Since all of the gain is depreciation recapture, the full gain on $30,000 is reported in the year of sale, even though the farmer only got $5,000 of cash.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
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