Taxation of Unrecaptured Section 1250 Gains

Tax, SDIRAs & Cost Segregation
2yFollow

Taxation of Unrecaptured Section 1250 Gains

Will B.
Member since 2024 · 4 posts · 1 vote

Hello!

Set of facts:

- Lived in a residential unit as a primary residence for a number of years.

- Converted to rental and depreciated it for 2 years.

- Sold in 2023.

- Purchase price: $250k

- Sale price: $350k

- Depreciation: $9k => Roughly ( ($250k*.50)/27.5yrs) *2yrs)

- 2023 marginal bracket: 32%

What is the proper taxation?

My work shows that the $100k is a Section 121 exclusion and leaves $0 tax owed.

The $9k depreciation recapture is tricky. I've filled out the 1040 Schedule D Tax worksheet 3 times and each time have come back with it being taxed at the marginal rate of 32%, with no particular special treatment, based on the flow of that worksheet I don't see how it could be any other way.

I have read many, many, many, many, many threads on this forum mentioning the recapture being taxed up to 25%. Has tax law changed recently or am I not filling out a form correctly?

1Reply
153 views

8 Replies

Jump to latestLatest
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Will B.

    No.. even though I normally do my own tax preparation, when it comes to depreciation recapture the IRS doesn't give you any info on how to fill it out.  There is so much interplay with other factors, that even if I looked up my old returns I am still not comfortable doing it myself.  Every time it was handled differently  LOL

    It should still be up to 25% (it could be less if your marginal bracket was less, but its not in your OP).

    Incidentally, you can offset the depreciation recapture with capital losses.  So maybe you have some from last year.

    0Reply
  • Nate MeekerBusiness Member
    Real Estate CPA | California · Member since 2020 · 544 posts · 251 votes
    2y

    @Will B. - at what point does your return on time payoff having a professional do it :D 

    The CPA Realtor 571 Reviews
    WebsiteView Page
    0Reply
  • Account Closed
    CPA · NY · Member since 2023 · 891 posts · 157 votes
    2y

    Firstly, you're correct about the Section 121 exclusion. The gain from the sale of a primary residence up to $250,000 (or $500,000 if married filing jointly) is generally excluded from taxation.

    Now, let's focus on the depreciation recapture. Depreciation is recaptured at a maximum rate of 25%. However, the remaining gain not covered by the Section 121 exclusion is taxed at your ordinary income tax rate.

    Here's how the calculation typically works:

    1. Calculate the Depreciation Recapture: The $9,000 of depreciation would be recaptured at a maximum rate of 25%, which is $2,250 (25% of $9,000).
    2. Calculate the Remaining Gain: Subtract the excluded amount (Section 121 exclusion) from the total gain: $100,000 (Total Gain) - $9,000 (Depreciation Recapture) - $250,000 (Section 121 Exclusion) = $0
    3. Tax the Remaining Gain at Ordinary Income Rate: Since the remaining gain is $0, there would be no additional tax on the gain.

    So, based on this calculation, it seems like there should not be any additional tax owed after taking into account the Section 121 exclusion and the depreciation recapture at a maximum rate of 25%.

    It's essential to review your calculations and ensure that you are accurately applying the exclusion and depreciation recapture. If you're using tax software, make sure all the relevant information is entered correctly, and consider seeking advice from a tax professional to ensure accurate and personalized guidance based on your specific situation.

    0Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    2y

    Correct - Depreciation recapture should be taxed at a maximum rate of 25%

    Is it possible that you are factoring in state taxes when you calculate 32%?

    [email protected]917-280-8544
    Basit Siddiqi CPA4.979 Reviews
    View Page
    0Reply
  • Will B.
    OP
    Member since 2024 · 4 posts · 1 vote
    2y

    Thanks for the responses. You all are confirming my broad understanding on the topic, but my trouble is in the specific technical reporting of this tax situation. How this should be reported in a general case would be helpful.

    As I follow schedule D, I get to an end result of the recaptured gains being taxed at my marginal rate above 25%. I am strictly looking at my federal return, nothing to do with state. Where does the depreciation recapture get capped?

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Will B.

    That's a tough one.  I find that its different for me each time because of various other circumstances of my financials.  Also, the IRS for some reason doesn't provide instructions on this matter.

    Just to cover some basis...  You are doing form 4797, right?  That sends you back to SchD with your recover values.  From there, usually on the 2nd page you wind up on one of the worksheets.  so, the calculations are "off form."

    Its also really convoluted since the gov has the concept that it can't tax you at a higher rate than your current rate.  So, if you are in the 24% marginal tax bracket, the depreciation unrecapture will be at 24%, not 25%.

    There is probably one small "interpretation" issue that you are having with the worksheet.  i find them to be very "tricky."  Just have your return done professionally and then you'll see how its done for future use, in this situation.

    Sorry.

    0Reply
  • Will B.
    OP
    Member since 2024 · 4 posts · 1 vote
    2y

    Yes, I have filled out 4797 regarding the property sale figuring basis and gain. Note, I only used straight-line depreciation so line 26 is blank/0's.

    I have filled out the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions. I have a reasonable number here that gets carried to Schedule D line 19. Schedule D line 20 directs to the Schedule D Tax Worksheet.

    I happen to have LTCG on line 15/16 of Schedule D, but those are unrelated to real estate.

    No matter how I fill out the Schedule D Tax Worksheet, I get 0 for lines 39 & 40 (the 25% taxed amount). I presume line 39 should contain the unrecaptured section 1250 gain.

    I am trying to work backwards from there to find how this could end up as a gain, but there's nothing obvious. I keep finding that the unrecaptured gain flows through further down to my marginal rate.

    0Reply
  • Will B.
    OP
    Member since 2024 · 4 posts · 1 vote
    2y

    Ok, this ends up being a simpler solution than I thought. I mis-stated my marginal bracket. My original post referred to a 32% marginal rate. The marginal rate is computed on all income except capital gains & depreciation recapture, whereas I was computing it on the full, combined amount.

    Thus, for good reason nothing is being taxed on the Schedule D Tax Worksheet above my 24% marginal rate. Oops!

    This is why the numbers for line 19 in that worksheet back out the 32% minimum threshold ($182,100 for single / $364,200 for MFJ) from your total income.

    Problem solved, thanks @David M.!

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free