Basis Adjustments for Depreciation Allowed or Allowable

The IRS stipulates (reference publication 946) that "You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitle to deduct. If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable."

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This often surprises Sellers of properties. In short, by example, say we have a property that was purchased for $500,000 and sold for $550,000 with $50,000 in deductible expenses. That would seem to mean "no tax due". In reality, when depreciation recapture is calculated, there is a tax due. 

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Take a residential property stipulating 27 years depreciation. Say the property was owned for 10 years. Per year that is $18,518 depreciation. Over 10 years that's $185,180. To find the taxable basis deduct the $185,180 from $500,000 for adjusted basis of $314,820. That means selling at $500,000 results in a $185,180  capital gain that is now taxable!