depreciation recapture when selling rental SFR

7 Replies

I can't deduct depreciation of rental SFR as I does not qualify as "active" real estate investor because I have full time day job and SFR rental is only part-time.

When I sell this rental SFR, I recapture depreciation which lowers my cost basis and increase my total gain and so increases my tax? Doesn't make sense as depreciation didn't lower my taxes to begin with. Is recapture my enemy because I am not "active" participatent in real estate?

Disclaimer: I am not a CPA.

Since you are doing this part time you are subject to passive loss rules. Basically you will accumulate your losses over the years. When you sell you would owe capital gains tax on net sell price -(tax basis + accumulated losses that could not be used). Look at the passive loss rules on the IRS website for more details.

Its likely you are actively managing your property.  Don't confuse that with the "real estate professional" status that would let you offset more ordinary income with passive losses.  Two different things, and you are correct that qualifying as a real estate professional is essentially impossible if you have a regular, full time job.  Even without being a RE professional, you can still deduct up to $25,000 in passive losses against other income if your AGI is under $100K. That $25K "special allowance" phases out if your income rises, though, $1 for every $2 of AGI over $100K.  So, if you have a good paying day job, you won't be able to offset your regular income with those passive losses.

If that's your situation, you don't loose the passive losses.  You carry those forward from year to year and then can use them to offset gains when you sell.  So, the depreciation reduces your basis, increasing your gain.  But then you subtract your disallowed carry forward passive losses, reducing your gain.

If you don't yet have an accountant, I highly recommend getting one.  I'm not out.  This is complicated stuff.

Thanks Jon.

I was thinking of having my wife get realtor license (she is home-maker currently) and then as we file jointly was thinking of doing that way to be able to use depreciation deduction from rental SFRs against my full-time W2 wage income.

You might have made a mistake on your previous tax returns on taking depreciation. For someone like you who cannot offset your "depreciation" losses with your W-2 income, you can offset it with your passive rental income. Furthermore, if you cannot take the full depreciation amount, it can be carried over the following years, so by the time you sell there should be a large accumulated carryover loss that offsets your gains. Here's an example:

W-2 income: 100K
net rental income: 10k
depreciation: 15k

On your taxes you will report the following to be taxes:

Total income W-2 and rental: 100k (because depreciation cancels out the 10k in rental income and then some)
Carryover depreciation to next year: 5k

Let's say that's the case for 5 years and now you've accumulated 25k in carryover depreciation that you haven't used yet. Let's now say you sell for the same price you bought to make calculations simple. Over those past 5 years, you've claimed 75k in depreciation (15k x 5 years) which must be reported, but out of the 75k, 25k is offset by the carryover losses. So now you've got to report 50k in depreciation which you should've used in this case. Sounds convoluted but such is the nature of taxes. Feel free to ask if something is unclear. I'm also not a CPA but I do my own taxes and that's how I understand it.

Typically, for a high W2 earner, you benefit from the depreciation because it lowers your taxes at say 28% or higher on the rental income, but the max that you pay back is 25% when it's recaptured when you sell. Hope that helps.

A real estate license does not make your a real estate professional for the IRS.  To be an RE pro you must spend at least 750 hours a year on real estate activities OR more hours than you spend on any other job.  That's basically 15 hours a week.  If your wife does 15 hours a week, you can use that to take more passive losses than allowed by the special allowance.  A RE license is irrelevant.

Thanks Jon

Sounds to me depreciation in my case does not help (as I can't use to to offset my W2 income) but it does not hurt either as when I sell because of what you said eariler

So, the depreciation reduces your basis, increasing your gain. But then you subtract your disallowed carry forward passive losses, reducing your gain.

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