Help me understand depreciation recapture!

[Matt W.]

Hi BP, 

I wanted to post to make sure I'm understanding the depreciation recapture process using an overly simplified example.  I'm leaving out deductions for closing costs, maintenance, repairs etc.

Say I buy a house for $300k, land value is $100k. I know you deduct the standard 1/27.5th of the improvement value, $200k.  After 5 years I sell the house for $400k.

So $200k x 3.636% x 5 years = $36,360 deducted. So when I sell the profit is actually $100k plus $36,360, correct? 

Also, does it really matter if I am "adding to the profit" side of the equation or "deducting from the basis" side? Seems like it's just 6 of one, half dozen of the other.

Thanks.

[Wayne Brooks]

The capital gain, $100k, is taxed at capital gain rates.

The $36,360 in depreciation recapture is added to and taxed as ordinary income (No ss/med tax) up to a max rate of 25%….since it was deducted from your ordinary income as you claimed it each year.  If you couldn’t claim it due to a high income level, they offset each other.