Depreciation recapture on a business sale: how $300,000 of equipment gain is taxed as income

Depreciation recapture on a business sale comes down to 2 numbers

For each Section 1245 asset (lifts, diagnostic gear, tow trucks, purchased intangibles), the ordinary-income part is the lesser of two numbers: the gain on the sale, and the depreciation, Section 179 and bonus deductions you already took. Sell a lift for $40,000 after deducting it down to $10,000 and the gain is $30,000, all of it ordinary. Any gain above the original cost is Section 1231 gain, usually taxed as long-term capital gain.

Real property follows a different rule. Depreciation on a shop building is unrecaptured Section 1250 gain, taxed at up to 25% for individuals rather than at full ordinary rates. Both kinds are reported on Form 4797, which is where your CPA will total them.

A rough test tells you whether this deserves a model. If accumulated depreciation on the fixed-asset schedule exceeds about 10% of the expected price, work out recapture before choosing a structure. Doug's $700,000 of depreciation against a roughly $2,500,000 business is 28%, nearly three times that line. A consulting firm with a laptop and a desk will rarely repay the afternoon.

I'll pay the capital gains rate on the whole sale

Doug believes the entire sale will be taxed at the capital gains rate, because that's how a friend described his own deal. When a buyer purchases assets, the price is split by asset class on Form 8594, which buyer and seller both file. Goodwill is usually capital gain. Equipment, up to its prior depreciation, is ordinary income, and so is parts inventory (though it isn't recapture).

The answer flips at the purchased-goodwill row: goodwill you built yourself is capital gain, but goodwill you bought with an earlier shop carries ordinary income up to the amortization already taken.

Three exceptions change the picture. In a stock sale of a corporation, the seller usually reports capital gain on the shares and the buyer inherits the low asset basis, which is why buyers push for asset sales (the site's asset sale versus stock sale page covers that in detail). Selling a partnership or multi-member LLC interest doesn't escape either, because Section 751 still carves out the recapture share as ordinary income. And in a C corporation asset sale, recapture is taxed inside the corporation at its flat rate, so the ordinary-versus-capital split matters less than the second layer of tax when cash is paid out to you.

I'll spread the tax over 10 years with a note to Heather

A hypothetical person, Doug, 68, starts from the fixed-asset schedule his CPA attaches to the shops' tax return. It lists lifts, alignment racks and tow trucks bought for $800,000, with $700,000 of depreciation claimed, which leaves a $100,000 basis. An appraiser values that equipment at $400,000 for a sale to Heather. Doug expects the 10-year note to spread his tax over 10 years.

The arithmetic says otherwise. The gain is $400,000 − $100,000 = $300,000. All of it is recapture, because $300,000 is below the $700,000 already deducted. At an assumed 35% rate, the tax is $300,000 × 35% = $105,000. Year-1 principal on the equipment is $400,000 ÷ 10 = $40,000, so Doug owes $105,000 on cash of $40,000 and faces a $65,000 gap.

The rule behind it is IRC Section 453(i): all recapture income is reported in the year of sale even under the installment method. Only gain above the recapture amount, on goodwill for example, is spread as Heather pays. Electing out of the installment method changes when the remaining gain is taxed, not the ordinary character of the $300,000.

Tax-first in practice means that before Doug signs the note, Corient Wealth Management estimates the year-1 tax cost and sizes Heather's down payment to cover it. A down payment of at least $105,000 means Doug isn't funding the tax from his savings. The rule to apply today: if you sell depreciated equipment on an installment note, set the down payment, or a cash reserve, at least equal to the tax on the full recapture amount. That tax is due for the year of sale no matter when the buyer pays.

Look at what the note actually did. It pushed some tax on goodwill into later years and saved nothing on the equipment. Most recapture planning just shifts the bill between years or between people. Only two moves shrink it: selling below original cost, or keeping the assets until Doug dies so Heather inherits them at fair value.

If I gift the shops at 68, the recapture goes away

Doug also thinks a gift would erase the recapture, and it doesn't. A gift moves it. Heather takes Doug's $100,000 carryover basis along with the $300,000 recapture potential, which becomes her ordinary income if she later sells the equipment. Assets held until Doug's death generally get a basis equal to fair value, which removes the recapture. With a $15,000,000 per-person estate exclusion (IRS, 2026) and a roughly $2,500,000 business, estate tax isn't what limits that choice. Gifts above $19,000 per recipient each year require Form 709.

When does a Section 179 deduction before a sale backfire?

A Section 179 deduction backfires when you expense equipment in the 1 to 2 years before a sale and then sell it near cost. You get the deduction now, and the same amount returns as ordinary income in the sale year, often at a higher rate because it stacks on top of the sale gain.

Expensing $150,000 of new lifts the year before a sale costs nothing this year, because it saves about $36,000 at an assumed 24% rate. If the lifts then sell near cost, the $150,000 comes back as recapture taxed at 37% on top of the sale gain, about $55,500, a net loss of $19,500. The top federal rate of 37% applies above $640,600 for a single filer in 2026, and a sale year pushes many owners there.

Timing goes wrong the other way too. The price allocation is effectively set once the letter of intent and purchase agreement are drafted, and the buyer wants equipment allocated high for fast write-offs. Negotiate the allocation before the letter of intent is signed, with a recapture estimate in hand.

Order matters as well. Gifting shares after a binding sale agreement exists can be treated as an assignment of income, leaving the gain taxed to the giver. Gifts have to come before a deal is substantially agreed. For other traps of this kind, see the site's article on 7 mistakes when selling a small business that raise your tax cost.

5 pieces of paperwork that set the recapture number

Start with the fixed-asset and depreciation schedule from your CPA, attached to Form 1120-S, Form 1065 or Schedule C. Past Forms 4562 show your Section 179 and bonus elections year by year. If you bought any shop, its purchase agreement shows the original allocation, since purchased goodwill carries recapture too. Add a current equipment appraisal, which sets the sale value, and the vehicle titles with loan payoff letters. Gather all five before the first meeting with a buyer, because every one of them feeds the lesser-of figure.

What happens if health, values or tax law change after the sale?

Three things can change after you sign: your health, the buyer's ability to pay, and the tax law. Each one hits a different year's tax cost, and the recapture reported in year 1 stays reported either way. Securing the note with the equipment and holding a cash reserve covers most of it.

If Doug dies with years left on the note, the unpaid balance is income in respect of a decedent with no step-up. Heather or the estate reports the remaining gain as payments arrive, while the recapture was already taxed in year 1. If Heather stops paying, Doug has already paid the year-1 tax on cash he never received, which is why the reserve exists.

Ordinary rates and bonus depreciation rules can change, and recapture is figured under the rules in force in the year of sale. Rerun the estimate at each review before closing. If Doug invests the proceeds while the note runs, past returns don't predict future ones, and his principal can fall.

The recapture math you can run alone, and where Corient Wealth Management comes in

You can pull the fixed-asset schedule and compute the lesser-of figure asset by asset in an afternoon. The allocation in the letter of intent, the note terms and down payment, and the gift-versus-sale timing are worth a conversation with Corient Wealth Management, because each one changes the tax cost in a different year. Family succession and exit planning are also separate topics the site covers.