@stech
Depreciation and recapture is definitely something you must be aware of if you are going to be in business. You can read this to get started.
https://www.irs.gov/pub/irs-pdf/p544.pdf
Let me give you an example of how it works in your favor. Suppose you buy a computer for $2000, exclusively for business, which has a class life of five years. You deduct $400 of depreciation as a business expense every year for five years. At the end of that time, the computer is worthless and outdated, so you throw it away. You were able to deduct the full cost of the computer over its useful life, which is exactly what is supposed to happen.
Now, let’s suppose you sell the used computer for $200. You have been taking depreciation based on the concept that the computer will be used up and worthless after five years. Every year that you take the $400 depreciation deduction, you are taking $400 that you invested in the computer out of the computer. By the end of the depreciation life, you don’t have any of your own money invested in the computer anymore. It’s adjusted cost basis is zero, it has cost you nothing to use that computer for five years. If you now sell the computer for $200, you are making a $200 profit on some thing that is theoretically worthless. The computer has no value, because you depreciated it, so that $200 represents a recapture of the depreciation deduction that you previously took. Therefore, that $200 is taxable income. You don’t have to pay tax on the entire $2000, you only have to pay tax on the amount that you recaptured in the sale.
Commercial property depreciates over 40 years. Most factories or shopping centers will not be worth as much at the end of that time, simply due to wear and tear and because time and technology march on. But because most houses and residential real estate appreciates significantly in value, it will almost always be the case that you will sell your house for more than you paid and that means that any depreciation deduction that you claimed for wear and tear gets re-captured in the sale. Taking a depreciation deduction for your home office is essentially saying that your house is worth less each year because of the business use and therefore the lost value is a business expense. Since you will probably sell the house for more than you paid for it, you are proving that the house did not really lose value, and so you have to pay back the depreciation that you previously took. And the tax regulations require that you must repay the depreciation that you claimed or could have claimed.
even so, there is value to taking depreciation using a concept called “present value of money“. Suppose you took a $1500 deduction each year for 10 years, and at the end of that time you sold the house, and had to include $15,000 extra in your taxable income for the recapture. Because of inflation, $15,000 10 years from now is less real money than $15,000 today. If you simply took the $400 in net tax savings from the deduction and invested it for 10 years you would have more money at the end of that 10 years than the tax you would owe on that recaptured income.
