Question

Explain the theory behind Section 1245 depreciation recapture discussed in Chapter 7. Do you agree with this? Why or why not?

Answer 1

The theory is to charging tax on the gain of selling asset, since the amount of depreciation charged in each year reducing the taxable income of that year.

Example: A machine is purchased three years ago at a cost of $55,000. It has the useful life 10 years, and accumulates depreciation $16,500. It is now sold at $40,000.

Solution: Total gain on selling = (Selling amount + Accumulated depreciation) – Cost of machine

                                                = ($40,000 + $16,500) - $55,000

                                                = $56,500 - $55,000

                                                = $1,500

The amount of gain is $1,500; tax would be charged on such amount.

This concept must be agreed. This theory indicates that a taxpayer enjoys benefit out of the depreciation-deduction in the income statement, because this is an implicit cost; therefore, there is nothing wrong charging tax on the gain amount if the asset is sold.