Installment sale and depreciation recapture - example given

[Bruce Reeves]

Found the example below on a website. This is the way I understand my first year tax liability when selling via installment sale. But after way too much time searching online, I get conflicting advise. I modeled a pro forma in my TurboTax and did not get this result. 

What does BiggerPockets say?

Let’s say you purchased a property for $400,000 and owned it for ten years. The property’s annual depreciation would be approximately $14,545.45 ($400,000/27.5 years).

• Your adjusted cost basis would be $400,000 – ($14,545.45 x 10) = $254,545.50
• So the realized gain on your sale would be $500,000 - $254,545.50 = $245,454.50
• The depreciation recapture tax would be 25% x $245,454.50 = $61,363.62

The challenge here is that depreciation taxes aren’t deferred or “spread out, " unlike capital gains taxes.” According to the IRS, you must report “any portion of the gain from the sale of depreciable assets that’s ordinary income under the depreciation recapture rules in the year of the sale.” In English, this means you must report the entire depreciation recapture amount – and pay that tax – to the IRS in the same year the sale takes place.

[Joe Vesey]

Quote from @Melanie P.:

Quote from @Bruce Reeves:

Quote from @Melanie P.:

You wouldn't have 10 years depreciation in the first year of ownership.

Depreciation is calculated on the value of the improvements only, land is not depreciable, so you wouldn't depreciate from the full purchase price ever as real estate sales generally include land and improvements.

I'm not following your response. The example show ten years of deprecation totaling $254,545.50. But I'm not concerned with that. I am looking for feedback on the first year tax liability of depreciation recapture of $61,362.62 with an installment sale.

 Sorry I misunderstood your terminology the first time I read it. You will calculate the correct amount of depreciation recapture by removing the cost of the land from how you calculated above and taking 10 years. If you do an installment sale you will pay in the first year and subsequent years the pro rata depreciation recaptured through installment sale income reported on Form 6252. It's impossible to calculate without knowing all the terms of the deal you're trying to make. 

Better options are to leave it to someone or to do a 1031 exchange, which you can do just for the recapture. You don't have to put the capital gain or the undepreciated principal into other real estate.

It is my understanding that capital gains taxes can be spread out over the life of the note, but that depreciation recapture taxes cannot.  Plus, I would thoroughly investigate trying to utilize a 1031 exchange as it can be challenging if you are using seller financing.  @Dave Foster can provide additional insight on the exchange options.