Depreciation reduces the tax basis of an asset dollar for dollar: every deduction you claim lowers the figure the IRS treats as your remaining investment in the property, which is called the adjusted basis.1Internal Revenue Service. Publication 551, Basis of Assets – Section: Adjusted Basis That matters most when you sell. The gain the IRS taxes is sale price minus adjusted basis, so years of depreciation deductions typically produce a larger taxable gain than the property’s actual appreciation would suggest.
The Mechanics: Cost, Improvements, Minus Depreciation
Your starting basis is what you paid for the asset, including acquisition costs like sales tax or settlement fees.2Internal Revenue Service. Topic No. 703, Basis of Assets Capital improvements that extend the asset’s useful life or add new functionality push that figure up. Routine maintenance and repairs don’t. From the running total, Section 1016 requires you to subtract every depreciation deduction taken since the asset was placed in service.3Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
A short worked example:
- Purchase price: $50,000
- Capital improvements: $5,000
- Total investment: $55,000
- Accumulated depreciation claimed: $20,000
- Adjusted basis: $35,000
The adjustment only runs one direction for depreciation. Improvements can lift the basis back up, but every annual deduction pulls it down again. Hold the asset long enough and accumulated depreciation can push the adjusted basis close to zero.
The “Allowed or Allowable” Trap
Skipping depreciation on your return does not preserve your basis. Section 1016 and IRS Publication 946 both require a reduction for the greater of depreciation “allowed” (what you actually claimed) or “allowable” (what you were entitled to claim).4Internal Revenue Service. Publication 946, How To Depreciate Property – Section: Adjusted Basis3Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis You can miss years of deductions and still see your basis drop as if you’d taken every one. At sale, the IRS computes gain using that lower basis. You lost the deduction and you pay tax on the phantom benefit.
If you find you’ve under-deducted in prior years, the correction is Form 3115, a request to change your accounting method. It triggers a Section 481(a) adjustment that catches up the missed deductions in the current year. For a negative adjustment, the kind that results from under-depreciating, the entire catch-up typically applies in the year of the change.5Internal Revenue Service. Instructions for Form 3115 The lesson is simple: claim every dollar you’re entitled to, because the basis reduction happens either way.
What a Reduced Basis Costs You at Sale
Selling a depreciated asset is where the basis arithmetic turns into a tax bill. Gain equals sale price minus adjusted basis.6Internal Revenue Service. Publication 544, Sales and Other Dispositions of Assets – Section: Gain or Loss From Sales and Exchanges Because depreciation has shrunk the subtraction, the gain is often larger than the property’s price change alone would produce. The IRS then splits that gain into layers under the depreciation recapture rules, taxing each layer differently.
Equipment and Other Personal Property: Section 1245
For equipment, machinery, vehicles, and similar personal property, Section 1245 recaptures all gain attributable to prior depreciation as ordinary income.7Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property For 2026, ordinary rates run as high as 37 percent.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Long-term capital gains rates of 0, 15, or 20 percent only apply to gain above the original cost.
Say you bought equipment for $60,000, claimed $40,000 in depreciation, and sold it for $55,000. Adjusted basis is $20,000 and gain is $35,000. All $35,000 is ordinary income under Section 1245, because the whole gain sits inside the depreciation you previously claimed.
Buildings and Real Property: Section 1250
Real property runs through Section 1250.9Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty Because MACRS requires straight-line depreciation on real property, Section 1250 itself rarely produces ordinary-income recapture. The depreciation portion of the gain is instead “unrecaptured Section 1250 gain,” taxed at a maximum rate of 25 percent. Gain above the original cost is taxed at the usual long-term capital gains rates.
A commercial building bought for $500,000, with $100,000 of straight-line depreciation claimed, has an adjusted basis of $400,000. Sell it for $600,000 and the $200,000 gain splits in two: the first $100,000 (matching the depreciation) is taxed at up to 25 percent, and the remaining $100,000 (true appreciation above cost) gets long-term capital gains treatment.
Section 179 and Bonus Depreciation Can Zero Out Basis in One Year
Regular MACRS whittles basis down over several years. Two provisions can erase it in one.
Section 179 lets you deduct the full cost of qualifying business property in the year it’s placed in service. For 2025, the maximum deduction is $2,500,000, with a phase-out that begins when total qualifying property exceeds $4,000,000; both figures adjust annually for inflation. Expense $80,000 of equipment under Section 179 and your basis in it drops to zero immediately.
Bonus depreciation under Section 168(k) works similarly and applies automatically to qualifying new and used property unless you elect out. The One Big Beautiful Bill Act reinstated 100-percent bonus depreciation for property placed in service after January 19, 2025.10Internal Revenue Service. One, Big, Beautiful Bill Provisions A business that buys $500,000 of qualifying equipment can deduct the full amount in year one, leaving each asset with an adjusted basis of zero.
Zero basis means any future sale price is entirely taxable gain, and under Section 1245 that gain comes back as ordinary income up to the depreciation taken. The upfront savings are real. The recapture bill on resale or trade-in can be large, and it tends to catch owners by surprise years later.
Assets Depreciation Doesn’t Touch
Some property keeps its original basis because it can’t be depreciated at all. Land is the main one: it doesn’t wear out or become obsolete, so no depreciation applies.11Internal Revenue Service. Publication 946, How To Depreciate Property When you buy a property that includes both land and a building, you have to allocate the purchase price between them, and only the building portion depreciates and loses basis.
Other categories outside depreciation include inventory held for sale, property placed in service and disposed of in the same year, and personal-use property such as your home or personal car. If you later convert personal-use property to business use, the depreciable basis is the lower of the property’s fair market value on the conversion date or your adjusted cost basis at that time.11Internal Revenue Service. Publication 946, How To Depreciate Property
Inheritance Resets the Clock
When you inherit a depreciable asset, the previous owner’s depreciation history drops away. Under Section 1014, inherited property gets a basis equal to its fair market value on the date of the decedent’s death.12Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If a parent bought a rental building for $300,000, claimed $100,000 in depreciation to reach an adjusted basis of $200,000, and the building was worth $450,000 at death, your starting basis is $450,000. You then run your own depreciation schedule from that figure. For long-held rental property or heavily depreciated business equipment, where the prior owner’s basis may have been near zero, the step-up erases the built-in gain, including the portion that came from decades of depreciation.
Keep the Schedule
The adjusted basis you carry on paper is the number that decides your gain, your recapture, and the character of each tax layer at sale. A year-by-year depreciation schedule for every asset, kept from the date it was placed in service through the date it leaves your hands, is the cleanest way to make sure the figure you report matches the figure the IRS will accept.