What Does Recovery Period Mean for Taxes?
The recovery period of an asset is the length of time over which the Internal Revenue Service requires you to depreciate it. These periods theoretically track the actual useful life of an asset so, for instance, an office building has a much longer life than a computer. Depreciation can be a major source of tax savings for companies, although assets that are resold after the end of their recovery periods can also generate significant tax liability.
Depreciation is the means by which your business realizes the cost of items that they buy that are assets, as opposed to expenses. If you buy a pen, the IRS lets you expense it since, very soon, the pen will be gone. A printing press, on the other hand, has a long life and gets carried on your books as an asset, but it doesn't last forever. The depreciation system lets you claim a portion of the cost of the asset every year during the asset's recovery period until it gets zeroed out. At that point, the asset should be not only worthless from a tax perspective but also should be used up from a practical perspective.
The Modified Accelerated Cost Recovery System has two recovery periods for many different assets, giving you some flexibility in how you depreciate business assets. For instance, office furniture has a 7-year life under the General Depreciation System and 10 under the Alternative Depreciation System. Computers and peripherals and cars have 5-year lives under both systems. Commercial real estate buildings get depreciated over a 39-year recovery period under both systems but land improvements like parking lots last 15 years under GDS and 20 under ADS.
Your business might be able to expense certain capital purchases in the year of their purchase rather than depreciating them. To do this, you may be able to take advantage of Section 179 of the tax code. The terms of the Section 179 deduction tend to change depending on how Congress sets up the tax code, but, for the 2012 and 2013 tax years, your business can expense up to $500,000 of qualifying capital purchases as long as it does not spend more than $2,000,000 on total qualifying capital purchases. Some classes of capital assets, like real estate or real estate improvements, are excluded from the Section 179 deduction, so it is always wise to check with your accountant before making capital investments.
Depreciation simulates an asset being used up until it has no value. If you sell a fully depreciated asset, the IRS will want some of the money that they allowed you to write off as depreciation back. Calculating how a piece of sold property is to be taxed can be complicated and is best left to a qualified accountant since there are different tax rates that could come into play, but you can expect that any money that you receive above your depreciated value, which is zero after the recovery period, will be taxed.