BiggerPockets

This issue has been discussed a few times before. I'll wade in yet again, since I now have a new CPA who seems to actually understand real estate investing.

I assume you are referring to the straight line 27.5 year depreciation that's currently allowed, and not the accellerated depreciation allowed on some properties acquired long ago.

It is my understanding, confirmed by recent and in-depth conversation with my new CPA, that you will have to pay depreciation recapture tax on the amount of the depreciation when you sell the property. Depreciation reduces the basis, and so increases your gain on the sale.

This is different than in another thread where RECPATAXMAN and I discussed this point, and came to the conclusion that the depreciation recapture applied only the accellerated portion. Since accellerated depreciation doesn't apply to properties purchased recently (sincee 1987?), you wouldn't have to pay the recapture tax. According to my new CPA, which has extensive real estate experience, that's incorrect. Yes, there was a recapture tax for accellerated depreciation. Maybe still is, if you have a property under those rules. The recapture for the straight line depreciation is different and does still apply.

Its also my understanding that the basis for your property is reduced by the depreciation allowed, not the depreciation taken. So, doesn't matter whether you take it or not.

I'm sure you'll get other posters with different responses.

Jon

I'm not confused, but after reading extensively on this topic, having previous discussions here on bigger pockets, and discussing it will two different accountants, I'm not 100% confident of the answer.

I believe the answer is that you have to pay depreciation recapture tax, currently 25%, on the portion of the gain on a sale that is attributable to the depreciation allowed on the property. Your basis is reduced by the depreciation allowed. The gain is the sale price (less all sales costs) minus the basis. The portion equal to the depreciation allowed (or the total gain, if less) is subject to recapture tax. The remainder is subject to capital gains tax.

I'm actually pretty confident about this answer. My new accountant is quite knowledgable and experienced, and spoke to both this form of recapture tax and the older accellerated depreciation recapture tax.

Jon

My understanding is that the IRS will consider you to have taken the allowed depreciation each and every year, regardless of whether you actually take it or not.

When you do sell it, that expected depreciation will be factored into the gain on the property.

I'm pretty suprised your accountant is telling you to not take your depreciation each year. From what I have seen there is really not a lot of wiggle room on it.

Ya you might as well take it cause if you don't the IRS assumes you did. So when you sell you have to deduct that anyways.

Hey Joey,
I think you would have to file amended returns. As of now thru April 15, 2010 (or Oct 15 if 2006 went on extension), you would be able to amend back to 2006 tax return. The rule is that the amendment deadline is 3 years after return due date (2006 return would have been due Apr 15, 07 or oct 15 on extension).
Let me know if that makes sense...

Joey,

If you missed any depreciation, and have owned the property for more than three years, you can get it back all in one year without havign to file amended returns (file amended return if it's less than 3 years).

You can do this by filing for automatic IRS consent via IRS Form 3115 - Application for Change in Accounting Method.

I can't go into details here (I'm not a tax advisor so I encourage you to seek one accordingly). The above information is from Albert Aiello's Goldmine of Brilliant Tax Strategies. Worth the investment if you are serious about real estate.

Hi Joey,

The recapture tax is applied to depreciation ALLOWED, or depreciation TAKEN, whichever is greater.

So in other words, lets say you took no depreciation, or less than the IRS says you were supposed to. The IRS will recapture based on the depreciation ALLOWED (determined by taking the straightline deduction over 27.5 years).

It is possible for depreciation TAKEN to be greater than depreciation ALLOWED, for example if you accelerated depreciation deductions, and in this case (when TAKEN>ALLOWED), the recapture is applied to depreciation taken.

Originally posted by Joe Wilson

YES!!! take the depreciation, because it lowers your ORDINARY income, which is at higher rates (up to 35%) versus CAPITAL gain which is up to 20%.

Get another CPA.

Now this makes sense. I've been taking depreciation on my 1 rental property for 2 years, and always figured it would be a wash when I sold it, but it does actually save a few bucks in the long run. At least, until Obama raises the cap gains tax!

Don't sell... exchange!

At least that's my plan. With a 1031 exchange, you can upgrade that property into larger/nicer/higher income producing property and the capital gains tax gets deferred. However, if you exchange your way into a home you'd like to live in, move in for 2 years, then sell it and take the $500,000 exemption (if you're married) and repeat.

Oh, BTW, keep taking the deduction. I almost stopped as well because I feared the recapture, but if you use the 1031 exchange and homeowner's tax exemption effectively, you can avoid the tax.

Jon has it down! Seems everyone is ready for tax time, lol, but the only reason I jumped in is to suggest the OP to file an amended return since he didn't take the depreciation last year. You can go back three years and fix fould ups so long as you don't bring attention to the fact that you owe them (LOL)! So go back and fix it. Take the benefit, you're going to pay for it in the future as mentioned above....good luck, Bill