It's stuff like this that keeps CPA's busy!

Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..

Madeleine said:

I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.

There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.

I still don't understand how the recapturing works and am not looking forward to having to figure that out.

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I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.

It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.

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