Depreciation Recapture If you dispose of depreciable or amortizable property at a gain,you may have to treat all or part of the gain (even if it is otherwisenontaxable) as ordinary income. Section 1245 Property A gain on the disposition of section 1245 property is treated asordinary income to the extent of depreciation allowed or allowable.See Gain Treated as Ordinary Income, later. Any gain recognized that is more than the part that is ordinaryincome because of depreciation is a section 1231 gain. SeeTreatment as ordinary or capital under Section 1231Gains and Losses, earlier. Defined.Section 1245 property includes any property that is or has beensubject to an allowance for depreciation or amortization and is any ofthe following types of property. Personal property (either tangible or intangible). Other tangible property (except buildings and theirstructural components) used as any of the following. An integral part of manufacturing, production, or extractionor of furnishing transportation, communications, electricity, gas,water, or sewage disposal services. A research facility in any of the activities in (a). A facility in any of the activities in (a) for the bulkstorage of fungible commodities. That part of real property (not included in (2)) with anadjusted basis that was reduced by certain amortization deductions(including those for certified pollution control facilities,child-care facilities, removal of architectural barriers to personswith disabilities and the elderly, or reforestation expenses) or asection 179 deduction. Single purpose agricultural (livestock) or horticulturalstructures. Storage facilities (except buildings and their structuralcomponents) used in distributing petroleum or any primary product ofpetroleum. Buildings and structural components.Section 1245 property does not include buildings and structuralcomponents. The term "building" includes a house, barn,warehouse, or garage. The term "structural component" includeswalls, floors, windows, doors, central air conditioning systems, lightfixtures, etc. A structure that is essentially machinery or equipment is notconsidered a building or structural component. Also, a structure thathouses property used as an integral part of an activity is notconsidered a building or structural component if the structure's useis so closely related to the property's use that the structure can beexpected to be replaced when the property it initially houses isreplaced. The fact that the structure is specially designed to withstand thestress and other demands of the property and the fact that thestructure cannot be used economically for other purposes indicate thatit is closely related to the use of the property it houses. Structuressuch as oil and gas storage tanks, grain storage bins, and silos arenot treated as buildings, but as section 1245 property. Storage facility.This is a facility used mainly for the bulk storage of fungiblecommodities. Bulk storage means storage of a commodity in a large massbefore it is used. For example, if a facility is used to store orangesthat have been sorted and boxed, it is not used for bulk storage. Tobe fungible, a commodity must be such that one part may be used inplace of another. Gain Treated as Ordinary Income The gain treated as ordinary income on the sale, exchange, orinvoluntary conversion of section 1245 property, including a sale andleaseback transaction, is the lesser of the followingamounts. The depreciation and amortization allowed or allowable onthe property. The gain realized on the disposition (the amount realizedfrom the disposition minus the adjusted basis of the property). For any other disposition of section 1245 property, ordinaryincome is the lesser of (1) above or the amount by which its fairmarket value is more than its adjusted basis. See chapter 3 ofPublication 544. Use Part III of Form 4797 to figure the ordinary income part of thegain. Depreciation on other property or taken by other taxpayers.Depreciation and amortization include not only the amounts youclaimed on the section 1245 property but also the followingdepreciation and amortization amounts. Amounts you claimed on property you exchanged for, orconverted to, your section 1245 property in a like-kind exchange orinvoluntary conversion. Amounts a previous owner of the section 1245 propertyclaimed if your basis is determined with reference to that person'sadjusted basis (for example, the donor's depreciation deductions onproperty you received as a gift would be included). Depreciation and amortization.Depreciation and amortization deductions that must be recaptured asordinary income include (but are not limited to) the following items. Ordinary depreciation deductions. Amortization deductions for all the following costs. The cost of acquiring a lease. The cost of lessee improvements. Pollution control facilities. Reforestation expenses. Section 197 intangibles. Child care facility expenses before 1982. Franchises, trademarks, and trade names acquired beforeAugust 11, 1993. The section 179 expense deduction. Deductions for all the following costs. The cost of removing barriers to the disabled and theelderly. Tertiary injectant expenses. Depreciable clean-fuel vehicles and refueling property(minus any recaptured deduction). Any basis reduction for the investment credit (minus anybasis increase for a credit recapture). Any basis reduction for the qualified electric vehiclecredit (minus any basis increase for a credit recapture). Example.You file your returns on a calendar year basis. In February 1997,you bought and placed in service for 100% use in your farming businessa light-duty truck (5-year property) that cost $10,000. You used thehalf-year convention and your MACRS deductions for the truck were$1,500 in 1997 and $2,550 in 1998. You did not take the section 179deduction on it. You sold the truck in May 1999 for $7,000. The MACRSdeduction in 1999, the year of sale, is $893 (1/2 of $1,785). Figurethe gain treated as ordinary income as follows. 1) Amount realized $7,000 2) Cost (Feb. 1997) $10,000 3) Depreciation allowed or allowable (MACRSdeductions: $1,500 + $2,550 + $893)      4,943 4) Adjusted basis (subtract line 3from line 2)     $5,057 5) Gain realized (subtract line 4from line 1) 1,943 6) Gain treated as ordinary income(lesser of line 3 or line 5) $1,943 Depreciation allowed or allowable.You generally use the greater of the depreciation allowed orallowable when figuring the part of gain to report as ordinary income.If, in prior years, you have consistently taken proper deductionsunder one method, the amount allowed for your prior years will not beincreased even though a greater amount would have been allowed underanother proper method. If you did not take any deduction at all fordepreciation, your adjustments to basis for depreciation allowable arefigured by using the straight line method. This treatment applies only when figuring what part of gain istreated as ordinary income under the rules for section 1245depreciation recapture. Disposition of plants and animals.If you made the choice not to apply the uniform capitalizationrules, you must treat any plant or animal you produce (if the animalswere produced in 1987 or 1988) as section 1245 property. You mustrecapture the preproductive expenses you would have capitalized if youhad not made the choice by treating these expenses as ordinary incomewhen determining your gain on selling or disposing of the property.For section 1231 transactions, show these expenses as depreciation online 22, Part III, of Form 4797. For plant sales that are reported onSchedule F (Form 1040), this recapture rule does not change thereporting of income because the gain is already ordinary income. Youcan use the farm-price method or the unit-livestock-price methoddiscussed in chapter 3to figure these expenses. Example.Janet Maple sold her apple orchard in 1999 for $80,000. Heradjusted basis at the time of sale was $60,000. She bought the orchardin 1992, but the trees did not produce a crop until 1995. Herpreproductive expenses were $6,000. She chose not to apply the uniformcapitalization rules. Janet must treat the $6,000 preproductiveexpenses as ordinary income when figuring the gain on the sale. Livestock costs incurred before 1989.For livestock costs incurred before 1989, the IRS provided twosafe-harbor choices. These safe-harbor choices were not available tocorporations, partnerships, or tax shelters that were required to usean accrual method of accounting. For information on these choices, seeNotice 88-24 in Cumulative Bulletin 1988-1 and Notice88-113 modifying Notice 88-24 in Cumulative Bulletin1988-2. For information on the uniform capitalization rules, see chapter 7. Section 1250 Property A gain on the disposition of section 1250 property is treated asordinary income to the extent of additional depreciation allowed orallowable. To determine the additional depreciation on section 1250property, see Additional Depreciation, later. You will not have additional depreciation if any of the followingapply. You figured depreciation for the property using the straightline method or any other method that does not result in depreciationthat is more than the amount figured by the straight line method, andyou have held the property longer than a year. You chose the alternate ACRS (straight line) method for thetypes of 15-, 18-, or 19-year real property covered by the section1250 rules. You dispose of residential rental property or nonresidentialreal property placed in service after 1986 (or after July 31, 1986, ifthe choice to use MACRS was made). These properties are depreciatedusing the straight line method. Defined.Section 1250 property includes all real property subject to anallowance for depreciation that is not and never has been section 1245property. It includes a leasehold of land or section 1250 propertysubject to an allowance for depreciation. A fee simple interest inland is not section 1250 property because it is not depreciable. Gain Treated as Ordinary Income To find what part of the gain from the disposition of section 1250property is treated as ordinary income, follow these steps. In a sale, exchange, or involuntary conversion of theproperty, figure the amount realized that is more than the adjustedbasis of the property (in any other disposition of the property,figure the amount of the fair market value that is more than theadjusted basis). Figure the additional depreciation for the periods after1975. Multiply the lesser of (1) or (2) by the applicablepercentage, discussed later. Stop here if this is residential rentalproperty, or if (2) is equal to or more than (1). This is the gainthat is treated as ordinary income because of additionaldepreciation. Subtract (2) from (1). Figure the additional depreciation for periods after 1969but before 1976. Add the lesser of (4) or (5) to the result in (3). This isthe gain treated as ordinary income because of additionaldepreciation. Use Part III, Form 4797, to figure the ordinary income part ofthe gain. Additional Depreciation If you hold section 1250 property longer than 1 year, theadditional depreciation is the amount of actual depreciationadjustments that is more than the depreciation figured using thestraight line method. For a list of items treated as depreciationadjustments, see Depreciation and amortization underSection 1245 Property, earlier. If you hold section 1250 property for 1 year or less, all of thedepreciation is additional depreciation. Figure straight line depreciation for ACRS real property by usingits 15-, 18-, or 19-year recovery period as the property's usefullife. The straight line method is applied without any basis reduction forthe investment credit. You will have additional depreciation if you use the regular ACRSmethod, the declining balance method, the sum-of-the-years-digitsmethod, the units-of-production method, or any other method of rapiddepreciation. You also have additional depreciation if you chooseamortization, other than amortization on real property that qualifiesas section 1245 property, discussed earlier. Depreciation taken by other taxpayers or on other property.Additional depreciation includes all depreciation adjustments tothe basis of section 1250 property whether allowed to you or anotherperson (as for carryover basis property). Depreciation allowed or allowable.You generally use the greater of depreciation allowed or allowable(to any person who held the property if the depreciation was used infiguring its adjusted basis in your hands) when figuring the part ofthe gain to be reported as ordinary income. If you can show that thededuction allowed for any tax year was less than the amount allowable,the lesser figure will be the depreciation adjustment for figuringadditional depreciation. Applicable Percentage The applicable percentage used to figure the ordinary incomebecause of additional depreciation depends on whether the realproperty you disposed of is nonresidential real property, residentialrental property, or low-income housing. The applicable percentages fornonresidential real property and residential rental property areexplained next. The applicable percentage for low-income housing isexplained in chapter 3 of Publication 544. Nonresidential real property.For real property that is not residential rental property, theapplicable percentage for periods after 1969 is 100%. For periodsbefore 1970, the percentage is zero and no ordinary income will resulton its disposition because of additional depreciation before 1970. Residential rental property.For residential rental property (80% or more of the gross income isfrom dwelling units) other than low-income housing, the percentage forperiods after 1975 is 100%. The applicable percentage for periodsbefore 1976 is zero. No ordinary income will result from a dispositionof residential rental property because of additional depreciationbefore 1976. More information.For more information about depreciation recapture on section 1250property, see chapter 3 of Publication 544. Installment Sales If you report the sale of property under the installment method,any depreciation recapture under section 1245 or 1250 is taxable asordinary income in the year of sale. This applies even if no paymentsare received in that year. If the gain is more than the depreciationrecapture income, report the rest of the gain using the rules of theinstallment method. For this purpose, add the recapture income to theproperty's adjusted basis. If you dispose of more than one asset in a single transaction, youmust separately figure the gain on each asset so that it may beproperly reported. To do this, allocate the selling price and thepayments you receive in the year of sale to each asset. Report anydepreciation recapture income in the year of sale before using theinstallment method for any remaining gain. For more information on installment sales, see chapter 12. Other Dispositions Chapter 3 of Publication 544discusses the tax treatment of thefollowing transfers of depreciable property. By gift. At death. In like-kind exchanges. In involuntary conversions. Publication 544also explains how to handle a singletransaction involving multiple properties.