Small business owners have a number of options on how to organize their business for tax purposes. Many small, single owner, businesses are not incorporated, and are deemed "sole proprietors", in the eyes of the IRS. Other business entities, like C-Corporations, are taxed as a separate entity with distributions to owners taxed a second time as dividends. Still others are deemed "flow-through" entities like S-Corporations and Limited Liability Companies (LLC).

Understanding Tax Terms: Depreciation Recapture

One of the more unpleasant surprises that can hit a taxpayer occurs when you sell personal property, rental property or assets from your small business. This tax surprise is often associated with depreciation recapture rules.

Defined

Depreciation recapture refers to reducing the cost of an asset sold by prior period’s depreciation expense to determine whether taxes are owed on the sale of an asset and to determine the type of tax that must be paid on the sale of the asset.

Basis is a common term to the IRS, but one that probably does not enter into your everyday conversation. Understanding what it means, however, can have an impact on the taxes you pay.

Definition

Per the IRS;

Basis is generally the amount of your capital investment in a property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property.

In plain language, basis is the collection of tax rules that establishes the cost of your property. Once the tax basis is established, you can then apply that basis to determine whether there is a gain or loss on your property when it is disposed, exchanged or sold. Unfortunately, it is not quite that easy. There is also Cost Basis, Adjusted Basis, and Basis other than cost.