Published October 18, 2012

What is Depreciation Recapture?

By Paul Wormley

Yesterday I got the email below from a good friend who is considering selling his small business and is concerned about the potential tax liability that will be created by depreciation recapture at the time of sale.

_Paul & Hope all is well. Have you ever dealt with depreciation recapture issues during a transaction? For example, does a seller get worried about the potential tax consequences of a sale if they've depreciated assets in their business for years?  _

Here was my response:

Yes. We see it both in depreciation and inventory.

Depreciation recapture happens because a seller has used accelerated depreciation (particularly section 179 deductions) in order to reduce income taxes. However, the recapture is only a make-whole for the IRS. That is, the seller is not harmed by the recapture because it simply brings the tax bill back to what the seller would have paid had they not taken accelerated depreciation.

Same happens with inventory when a seller has aggressively marked down inventory in order to depress earnings and save on taxes. When a buyer puts the inventory on its balance sheet at fair market value, the seller faces recapture. However, just like depreciation, the taxes due by the seller are simply a catch-up or make-whole for the IRS. The seller is no worse off than if they had correctly accounted for the inventory in the first place.

So, that's a long way of saying that we don't make special considerations for sellers in these scenarios. We try to spend some time educating sellers on why the recaptures is not a "loss" to them in the transaction.

If you are considering selling your business and have questions about depreciation recapture, please contact us. We have experienced this situation many times and can walk you through the financial impacts of depreciation recapture.

Paul Wormley - General Partner

Paul joined Hadley Capital in 2005. He has spent his entire career working with small and emerging companies. Paul grew up in a family business environment and is an owner of his family’s community newspaper business. Paul works with GT Golf Supplies, Pneu-Con, Open Sky Media and Centare. He was the chairman of the board of directors for i-deal Optics, a previous Hadley Capital company.

Paul is an outdoor enthusiast who enjoys fishing, hunting, riding motorbikes, Crossfit and an occasional craft beer. He works closely with a number of non-profit organizations including One Acre Fund and Trout & Salmon Foundation, and serves as chairman of the Finance Committee at his church.

Paul is a graduate of the University of Colorado at Boulder and received an MBA from the Kellogg School of Management at Northwestern University. He and his wife, Rosemary, have three children.