Depreciation Recapture - Land Improvement

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Depreciation Recapture - Land Improvement

Michelle Hannah
Member since 2023 · 1 post · 0 votes

Hello!

I own and operate a full time short term rental. We added a pool to the home last year. When doing taxes it separates the assets, property & the new land improvement (pool). My question is, we would like to take the one time “special depreciation” on the pool to increase cash flow as the pool was very expensive but also bc we’re well aware we’re not going to get a 1 for 1 value of what the pool cost when we  eventually sell ,so it really does depreciate immediately… But how does depreciation recapture work when we sell the home one day? Since the sale will be for the property (incl the pool), not the property & pool separately, how is the cost basis calculated? Is the land improvement asset now just automatically combined with the cost basis of the house? I’ve been searching the internet for days and could not find an answer to this! Im a numbers gal so if you could help explain with an example that would be so great! Like purchase price of home $200,000, purchase price of pool $50,000, etc

*in case it’s relevant, we are doing straight line over 27.5 yrs for the home (bought separately from the pool). Did not plan on taking any section 179 1st year for the home, as I assume the home will appreciate over time. 

Thank you!!!

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Natalie KolodijBusiness Member
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Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
3y

Short-Term rentals should be depreciated on 39 year lives, not 27.5. 

A pool is land improvements at 15 years. 

When you sell you recapture that amount. 

Numbers so it helps you (Ignoring selling costs and such for simplicity) : 

When you sell you typically pay long term capital gains 

Gain= Sale price - Adjusted basis 

So if you buy a house for $200k and lets say $150k is building value $50k is land value 

For a STR

That $150k should be depreciated across 39 years= $3,846 annually 

So if you own it for 5 years that's about $19,000 of depreciation you've taken

So now your adjusted basis is $200k-$19= $181,000 

So if you sold for...$250k your gain would be $250,000-$181,000= $69,000 

BUT the portion of that gain that was created becusae you depreciated- gets recapture at your ordinary income tax rate capped at 25% - so $19k of that $69k gain= taxed higher, the remaining 50k taxed at lower long term cpa gain rate. 

So Same thing happens if we throw a pool in 

Adjusted basis originally = $200k 

Add a pool = $250k 

Immediatey depreciate a pool as a year 1 land improvement w/ bonus depreciation = basis reduced by $50k

So your adjusted basis is back to $200k 

IN the same example above ...5 years in: 

$250k (orginal purchase + pool) - 19k-50k (depreciation on house and pool) = $181k adjusted basis 

So if you sell for that same $250k- 181k adj basis= $69k gain

But the whole thing was caused by depreciation so since you've taken 69k of depreciation your entire gain would be taxed at the higher recapture rate 

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    3y

    @Michelle Hannah Depreciation recapture is depreciation recapture…..it doesn’t matter what is was for….it all gets combined and taxed when you sell.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    3y

    The pool is added as a separate asset. It is not added to the existing basis you are already depreciating. 

    Yes, you will sell the asset together. 

    You might want to confirm with your CPA if your 27.5 years is correct.

    Sec 179 is not relevant. 

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  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    3y

    Short-Term rentals should be depreciated on 39 year lives, not 27.5. 

    A pool is land improvements at 15 years. 

    When you sell you recapture that amount. 

    Numbers so it helps you (Ignoring selling costs and such for simplicity) : 

    When you sell you typically pay long term capital gains 

    Gain= Sale price - Adjusted basis 

    So if you buy a house for $200k and lets say $150k is building value $50k is land value 

    For a STR

    That $150k should be depreciated across 39 years= $3,846 annually 

    So if you own it for 5 years that's about $19,000 of depreciation you've taken

    So now your adjusted basis is $200k-$19= $181,000 

    So if you sold for...$250k your gain would be $250,000-$181,000= $69,000 

    BUT the portion of that gain that was created becusae you depreciated- gets recapture at your ordinary income tax rate capped at 25% - so $19k of that $69k gain= taxed higher, the remaining 50k taxed at lower long term cpa gain rate. 

    So Same thing happens if we throw a pool in 

    Adjusted basis originally = $200k 

    Add a pool = $250k 

    Immediatey depreciate a pool as a year 1 land improvement w/ bonus depreciation = basis reduced by $50k

    So your adjusted basis is back to $200k 

    IN the same example above ...5 years in: 

    $250k (orginal purchase + pool) - 19k-50k (depreciation on house and pool) = $181k adjusted basis 

    So if you sell for that same $250k- 181k adj basis= $69k gain

    But the whole thing was caused by depreciation so since you've taken 69k of depreciation your entire gain would be taxed at the higher recapture rate 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    @Michelle Hannah

    "I've been searching the Internet" is an unreliable approach when it comes to complex tax issues. (Probably unreliable for any issue, TBH.) And we're discussing it on the Internet, so there's more than a hint of irony.

    You have two assets now: a $300k house and a $50k pool (or whatever your real numbers are). The pool has been fully depreciated. When you sell the property, say for $500k, it will have to be allocated between the house and the pool.

    Let's allocate the $500k as $460k to the house and $40k to the pool. Since the $50k pool has been fully depreciated, the entire $40k is depreciation recapture.

    Let's now allocate the $500k as $440k to the house and $60k to the pool. Of the $60k, $50k is depreciation recapture and $10k is capital gain on the pool.

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