Capital Goods: Depreciation, Section 179, and Recapture Rules

Capital goods are the long-lived physical assets a business uses to produce goods or deliver services: machinery, vehicles, equipment, furniture, and the buildings that house operations. Because these assets last more than a year, the IRS won’t let you deduct the full cost the year you buy them. Instead, you capitalize the purchase and recover the cost over time through depreciation, though two provisions in effect for 2026 can accelerate most of that write-off into year one: a Section 179 deduction limit of $2,560,000 and permanently restored 100% bonus depreciation under the One Big Beautiful Bill Act.

What Counts as a Capital Good

To be treated as depreciable property under federal tax rules, an asset has to meet four tests: you own it, you use it in your business or to produce income, it has a determinable useful life, and it lasts more than one year.¹ “Determinable useful life” just means the asset wears out, becomes obsolete, or loses value over time. Land never qualifies, because it doesn’t deteriorate.

The range of qualifying assets is broad. A $500,000 CNC milling machine, a fleet of delivery trucks, an industrial printing press, a walk-in freezer bolted to a restaurant floor, and the warehouse holding inventory all count. So does off-the-shelf business software. The common thread is that each asset contributes to revenue across multiple years rather than getting consumed in a single production cycle.

Cost matters too. A $5 box of pens technically lasts more than a year, but nobody capitalizes it. The IRS provides a de minimis safe harbor that lets businesses expense items costing $2,500 or less per invoice ($5,000 for businesses with audited financial statements) without capitalizing them.² Anything above those thresholds that meets the four-part test gets capitalized.

One boundary worth naming: materials consumed during production, such as steel, lumber, fabric, or electronic components, aren’t capital goods. They’re intermediate goods, recorded as inventory and expensed through cost of goods sold when the finished product ships. The machine that cuts the steel is a capital good; the steel itself is not.

How the Cost Gets Deducted: Depreciation

Capitalizing an asset means spreading its cost over its useful life instead of deducting it all at once. A machine that earns revenue for seven years should have its cost matched against revenue over those same seven years. Depreciation is the mechanism that makes that happen.

For federal tax returns, most businesses use the Modified Accelerated Cost Recovery System. MACRS ignores salvage value and assigns every asset to a predetermined property class that dictates how many years the cost gets recovered over.¹ The default method uses a 200% declining balance calculation that front-loads deductions into the early years, giving you bigger write-offs when the asset is newest.

The property classes cover most business assets:

3-year property: tractor units for over-the-road use and certain racehorses.
5-year property: cars, trucks, buses, office machinery like copiers and calculators, computers, and research equipment.
7-year property: office furniture, desks, safes, railroad track, and any property without a designated class life.
10-year property: vessels, barges, and single-purpose agricultural structures.
15-year property: land improvements such as fences, roads, sidewalks, and retail fuel outlets.
27.5-year and 39-year property: residential rental buildings and nonresidential commercial buildings, respectively.

Depreciation is reported on Form 4562, Depreciation and Amortization, filed with your annual tax return.³ An asset that doesn’t fit a named class defaults to the 7-year category.

Section 179 and Bonus Depreciation for 2026

Standard MACRS stretches cost recovery over years, but two provisions let a business write off capital goods much faster. For most small and mid-size companies, these accelerated deductions are the reason a big equipment purchase pencils out in a given year.

Section 179 Expensing

Section 179 lets you deduct the full purchase price of qualifying equipment in the year you place it in service, up to a dollar cap. For 2026, that cap is $2,560,000. The deduction begins phasing out dollar-for-dollar once your total equipment purchases for the year exceed $4,090,000, and it disappears entirely at $6,650,000.⁴ Both figures are inflation-adjusted annually.

Qualifying property includes tangible personal property like machinery, equipment, and furniture; off-the-shelf computer software; and certain improvements to nonresidential buildings such as roofs, HVAC systems, fire alarms, and security systems.¹ Vehicles over 6,000 pounds gross vehicle weight rating qualify, though SUVs in the 6,000-to-14,000-pound range are subject to a separate cap of $32,000 for 2026.

Section 179 has one important limit: the deduction cannot exceed your business’s taxable income for the year. If your business earns $200,000 and you buy $300,000 in equipment, you can only deduct $200,000 under Section 179. The remaining $100,000 carries forward to future years.

100% Bonus Depreciation

The One Big Beautiful Bill Act permanently restored 100% first-year bonus depreciation for qualified property acquired after January 19, 2025.⁵ The entire cost of eligible new or used property can be deducted in the first year, with no dollar cap. Unlike Section 179, bonus depreciation can create or increase a net operating loss.

The practical difference comes down to flexibility. Section 179 is elective and capped, and it’s limited to taxable income. Bonus depreciation is automatic (you have to opt out if you don’t want it), uncapped, and can generate a loss. Most businesses apply Section 179 first up to its limits, then use bonus depreciation on any remaining cost.

When Later Spending Gets Capitalized: The BAR Test

Not every dollar spent on existing equipment counts as a new capital expenditure. Routine repairs and maintenance are deductible in the year paid. The IRS draws the line using the BAR test: an expenditure must be capitalized only if it results in a Betterment, Adaptation, or Restoration of the asset.²

Betterment: the work materially increases the asset’s capacity, productivity, efficiency, or output, or fixes a defect that existed before you acquired it.
Adaptation: the work converts the asset to a new or different use that wasn’t your original purpose when you placed it in service.
Restoration: the work replaces a major component, returns a non-functional asset to working condition, or rebuilds the asset to like-new condition after the end of its class life.

If the work doesn’t trigger any of those three, it’s a deductible repair. Replacing a worn belt on a conveyor system is a repair. Replacing the entire motor assembly that drives the conveyor is likely a restoration. This is where audits happen most often, because the incentive to call something a “repair” rather than a capital improvement is obvious.

A separate safe harbor covers routine maintenance: recurring activities you reasonably expect to perform more than once during the asset’s class life to keep it running normally. Oil changes on a fleet vehicle, annual HVAC filter replacement, and scheduled recalibration of manufacturing sensors all qualify. Routine maintenance that also happens to be a betterment still gets capitalized.²

Selling or Disposing of a Capital Good

Depreciation delivers tax deductions on the way in, and the IRS claws some of that benefit back when you sell the asset for more than its depreciated book value. This is depreciation recapture, and it’s one of the most common tax surprises for business owners.

Section 1245 Recapture

Most tangible business equipment falls under Section 1245. When you sell Section 1245 property at a gain, the portion of your gain attributable to depreciation you previously claimed is taxed as ordinary income, not at the lower capital gains rate.⁶ The recapture amount equals the lesser of your total gain or the total depreciation (including any Section 179 deductions) you took on the asset.

Say you buy a $100,000 machine, depreciate it down to $20,000 over several years ($80,000 in total deductions), then sell it for $65,000. Your gain is $45,000 ($65,000 sale price minus $20,000 adjusted basis). All $45,000 is taxed as ordinary income because it falls entirely within the $80,000 of depreciation you claimed. You got ordinary-income deductions going in, so the recaptured amount is treated as ordinary income going out.

Section 1231 Treatment

If you sell the asset for more than its original cost, the gain above the recapture amount qualifies as a Section 1231 gain. Net Section 1231 gains for the year are treated as long-term capital gains, taxed at more favorable rates.⁷ Net Section 1231 losses, by contrast, are treated as ordinary losses, which offset ordinary income. Gains get capital treatment; losses get ordinary treatment.

Watch the five-year lookback rule. If you claimed net Section 1231 losses in any of the previous five years that haven’t been offset by prior Section 1231 gains, your current Section 1231 gains are recharacterized as ordinary income up to the amount of those unrecaptured losses.⁷ The IRS doesn’t let you take ordinary-loss treatment one year and capital-gain treatment the next without settling up.

Sales of depreciable business property held longer than one year are reported on Form 4797, not Schedule D. Part III calculates the recapture amount, which flows to Part II as ordinary income.⁸ If you sell a building and the land underneath it in a single transaction, you allocate the sale price between the two based on fair market value and report each piece separately.

1
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
2
Internal Revenue Service. Tangible Property Final Regulations – Frequently Asked Questions
3
Internal Revenue Service. 2025 Instructions for Form 4562 – Depreciation and Amortization
4
Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets
5
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
6
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
7
Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets
8
Internal Revenue Service. Instructions for Form 4797