Depreciation Recapture - Basis

Basis

The starting point for determining when a depreciation recapture will occur is to determine the basis of the asset. There are three different types of basis: original, adjusted, and recomputed basis.

The original basis of an asset is usually the value of a taxpayer’s investment in the asset. (See IRC § 1012). When a taxpayer purchases an asset, the original basis is the purchase price, or cost, of the asset. Different factors, including tax deductions for depreciation, can lead to an adjusted or recomputed basis for the asset. (See IRC § 1016 and IRC § 1245(a)(2)(A)).

An adjusted basis under IRC 1016 is the original basis of a piece of property plus any increases for improvements to the property or any decreases for depreciation deductions allowed with respect to such property. So, if a taxpayer buys something for $100,000, and takes allowable deductions under IRC 167 for the next 3 years at $5000 per year, his adjusted basis is $85,000.

Recomputed basis under IRC 1245(a)(2) basically means, with respect to any property, its adjusted basis recomputed by adding all adjustments reflected on account of deductions allowed or allowable to the taxpayer for depreciation. In the previous example, the taxpayer’s recomputed basis would be $100,000 because you add to the adjusted basis the amounts the taxpayer depreciated.

If a taxpayer sells an asset for less than its basis, then the taxpayer has taken a loss. If the taxpayer sells the asset for more than its basis, the taxpayer has experienced a gain. For example, if a taxpayer purchased a widget for $1,000, the original basis of the widget would be $1,000. If the taxpayer sold the widget for $1,500, the taxpayer would experience a capital gain of $500.