@sidekickin wrote:
There are some additional details that are pertinent to this situation which will explain why I am asking about this. In the contract for the lease, after the initial 5 year term the payer has extended the option to purchase the equipment for the full amount that I paid for the equipment. However, if I continue for subsequent lease terms (5 years each), that option is no longer on the table and I would be lucky to receive MAYBE 50% of the original purchase price if I sold the equipment. The reason they are putting this option in the contract is because the company expects to be bought out by another company within 5 years and is doing this to protect me as an investor. So, with this additional information in mind, if I allowed the payer to buy the equipment for my original full purchase price at the end of the initial lease term (or the company is bought out and they fulfill the terms of the lease agreement), would I have to pay back any depreciation I deducted over that 5 year period? Are there any other things to consider in this type of situation?
Roughly speaking:
Suppose a $100,000 tractor, depreciated over 5 years. The lease is in place for 2 years, during which time you take $40,000 depreciation expense. Your adjusted cost basis is now $60,000. If you sell the tractor for $100,000, you have a taxable capital gain of $40,000 (sales price minus adjusted cost basis). In this case, since all the gain is due to depreciation, it is taxed as depreciation recapture, and not at the more favorable capital gains rates.
You deducted $40,000 in the past, now pay tax on the $40,000. It's a wash (in one sense) but it benefits you in another sense. $40,000 of taxable income 3 years from now is less real money (purchasing power) due to inflation, so it's still financially to your advantage to deduct the depreciation now and pay the tax later.
Your situation is odd; normally it would be more common to keep the equipment until it was no longer usable and then sell it for scrap or sell it used, either of which would create recapture, but much less than the original full price.
And also, very important. You must recapture depreciation you took or could have taken. So if you think that you will just not bother reporting depreciation to save paperwork, and therefore not report the recapture as taxable income, that's a huge mistake if you get caught.
