Depreciation Recapture for Contractors: The Tax Bill When You Sell Equipment

Episode 131 of Concrete Numbers · 5 min watch

Selling old equipment feels like a clean transaction. You offload the machine, take the cash, move on. But if you wrote that asset down over the years — and most contractors write assets down aggressively — the sale can hand you a tax bill you never budgeted for.

The mechanism is depreciation recapture, and it catches people because it turns on a number most owners never look at: their current basis, not what they paid.

What recapture actually is

Your tax basis in an asset is roughly what you paid minus the depreciation you have already deducted. Every write-off you take — regular depreciation, Section 179, bonus depreciation — pushes that basis down.

So take a simple case. You buy a machine for $10,000. Over the years you deduct $8,000 of depreciation. Your basis is now $2,000.

You sell it for $2,500. The instinct is that you barely made anything — you paid ten and sold for two and a half. But tax does not work from what you paid. It works from basis. Sale price of $2,500 against a basis of $2,000 is a $500 gain, and that gain exists precisely because you already took deductions for the decline in value.

The asset being old, mostly written off, and sold for a small number does not make the tax issue go away. It is often what creates it.

Why it is taxed at ordinary rates, not capital gains

This is the part that stings. People hear “gain” and assume capital gains treatment. For equipment, that is usually wrong.

Machinery, equipment and vehicles are Section 1245 property. Under that rule, gain on disposition is treated as ordinary income to the extent of the depreciation allowed or allowable on the asset. In practice the recaptured amount is the lesser of the total gain or the depreciation you previously took.

In the example above, the entire $500 falls inside the $8,000 of depreciation already claimed, so all of it is ordinary income — taxed at your regular rate, not a preferential one.

The phrase “allowed or allowable” deserves attention. If you were entitled to depreciation and did not claim it, the recapture calculation can still count it. Skipping a deduction does not protect you later.

Trade-ins stopped being a shelter, and many contractors have not caught up

This is the biggest practical change, and the script for this episode predates it being widely understood.

Trading a machine in against a new one used to be treatable as a like-kind exchange, deferring the gain into the replacement asset. That is no longer available for equipment. Since the Tax Cuts and Jobs Act, Section 1031 like-kind exchange treatment applies only to real property. Equipment and vehicle trade-ins no longer qualify.

What that means on the ground: a trade-in is now treated as a sale of the old asset and a separate purchase of the new one. The old machine’s gain is recognised immediately, recapture and all — even though no cash changed hands in your direction and the dealer paperwork makes it look like one transaction.

If you are replacing equipment on a rolling basis and assuming the trade-in washes out the tax, that assumption is several years out of date.

Destroyed, stolen, or otherwise gone

Disposal is not only selling. An asset that is destroyed or stolen can also produce a taxable event, because insurance proceeds are treated as an amount realised on the disposition.

There is relief available here that does not exist for trade-ins. Under the involuntary conversion rules, if you reinvest the proceeds in qualifying replacement property within the required period, gain can be deferred rather than recognised. If the replacement costs at least as much as you received, the whole gain defers; if you pocket part of the proceeds, that excess is generally taxable.

The deferral is not forgiveness — it reduces your basis in the replacement asset, which means the gain resurfaces later. But timing matters when you are rebuilding after a loss.

Real property follows different rules

If the asset is real estate rather than equipment, the recapture regime is different. Depreciated real property falls under Section 1250 rather than 1245, and the treatment of prior depreciation is not the same as the straight ordinary-income result above. Like-kind exchange deferral also remains available for real property, which is exactly the distinction that catches people who assume the equipment rules carry across.

The figures and rates in that area move, so it is worth getting the specific treatment confirmed against your actual holding period and depreciation history rather than assuming.

The planning point: a write-off has two ends

None of this makes accelerated depreciation a bad idea. Taking Section 179 or bonus depreciation on a machine is usually the right call, and the cash benefit is real.

But a write-off has two ends. Day one gives you the deduction. The disposal gives some of it back, at ordinary rates, at a time you may not choose. The contractors who get hurt are the ones who optimised only the first end — wrote everything down as fast as possible, then sold or replaced assets without modelling what came out the other side.

The decision worth making deliberately is the whole life cycle: how you acquire it, how you depreciate it, and what the exit looks like. If you are weighing a purchase against a lease on the same asset, our buy vs lease calculator for contractors runs both sides, and our construction accounting team can model the disposal before you commit rather than after.

Verified against IRC Section 1245 and IRS Publication 544 (sales and other dispositions of assets). General information, not advice for your situation.