Depreciation recovery is when an asset is sold for more than the depreciation claimed on tax returns, generating a gain that must be reported as income to the tax agency. This is often managed using specific forms, such as Form 4797 in the US.
Depreciation recovery is the generation of some type of gain that helps offset the previously incurred depreciation on an asset. In many cases, this recovery is generated when the asset is sold for more than the depreciation previously claimed on annual tax returns. Creating this type of gain requires that the recovered depreciation be reported as income to the appropriate tax agency.
One of the easiest ways to understand how depreciation recovery occurs is to consider a business that purchases some type of equipment for use in its operation. Once purchased, the equipment is used for several years and the company claims depreciation during each of those years, based on applicable tax laws. Over time, the total amount of claimed depreciation amounts to approximately sixty percent of the original purchase price.
After several years of use, the company is able to sell the used equipment for an amount that helps offset the amount of depreciation claimed on the series of annual tax returns. In this case, you need to report the depreciation recovery as income for the current period. Many national tax agencies have specific guidelines for calculating the amount of depreciation recovery that counts as income and often require specific forms to manage the reports.
For example, suppose the company originally paid $20,000 (US Dollars) for the equipment. Over the next six years, the company claims equipment depreciation to the tune of $12,000. During the seventh year, the company sells the depreciated equipment for $12,000. When the tax return for the seventh year is prepared, the company must report a depreciation recapture of $4,000, which is the difference between the depreciated tax base amount and the original sales price.
In many countries, the national tax agency will require the use of a specific form to report depreciation recovery and thus identify the source of the income. For companies operating in the United States, this is managed using Form 4797, a document provided by the Internal Revenue Service. Depending on the tax laws that prevail in a particular country, recapture income may be reported as a capital gain or simply as ordinary income. This makes it important to understand current tax regulations and how they apply to this report of recovered depreciation through asset sales.
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