Recapture (Taxation) Definition
Recapture concerns a situation in which a taxpayer records a tax deduction in one year but must report the amount of deduction as income in a later year.
A Little More on What is Recapture
Depreciation recapture takes place when the taxpayer sells an asset that has been depreciated. The depreciation resulted in a deduction in one year hat must be recaptured or added back in a later year.
The first step in the assessment of depreciation recapture involves the determination of the cost basis of the asset. This is the price that the buyer pays when buying the asset. The adjusted cost basis refers to the difference between the original cost basis and any associated allowable depreciation costs. For instance, Mr. A buys equipment for $10,000 that has a depreciation expense of $2000 per annum. Hence, the adjusted cost basis after a period of 4 years will be $2,000, that is $10,000 – (2,000*4).
The depreciation recapture takes place when Mr. A sells the equipment at a profit. If he sells the equipment for $3,000 after 4 years, then his taxable gain will be $1,000 ($3,000 – $2,000). It can seem like that the equipment bought for $10,000 and sold for $3,000 calls out for a loss. However, it is not the case as the profits and losses are based on the adjusted cost basis, rather than the original cost basis. In this scenario, Mr. A should report a recaptured profit of $1,000.