What Is Depreciation Recapture?
A known deal breaker for asset sale structuring is the Depreciation Recapture (built-in gains) that a seller has to pay. A former C corporation which makes an S election is subject to a corporate-level tax if it sells appreciated assets during the first 10 years that the corporation is an S corporation (under Internal Revenue Code 1373). The code defines the term “built-in gain” as the excess of the total value of all of the C corporation’s assets on the day it became an S corporation over the C corporation’s tax basis in all such assets on that day (i.e.. the gain). The build-in gain provision applies only to recognized gain. This corporate-level tax may be avoided by deferring the recognition of gain beyond the 10-year period. Deferral may be achieved, for example, by holding the property under a lease arrangement rather than transferring ownership. Note that the selling tax payer must always report depreciation recapture as income in the year of sale, regardless of the cash received
