Recapture Tax Help

3 Replies

Hi guys,

Had a few questions regarding recapture tax and was hoping someone could help.

1) Recapture tax is a federal rule/law and not at the state level correct?

2) Will you owe recapture tax when you sell your primary residence?

3) What is this about after 9 years, no recapture tax is due? Is that for both rental properties and primary residence?

http://www.wshfc.org/buyers/recapture.htm

I have a rental property that I've had for 10 years, purchase for $170k and sold for $160k. I was told that even tho I lost money, I would still owe recapture tax for the deprecation on the property for those 10 years, is that correct?

Thanks.

Depreciation and the tax on unrecaptured depreciation apply only to rentals, not your residence. Its a federal tax issue, though there might also be a similar state tax, too. The linked program is has nothing to do with depreciation recapture. That's dealing with some special lending program. It may apply, if you financed your properties with an applicable program.

Whether or not you have to pay it on the rental requires some math.

As you do your taxes each year you will take depreciation on the rental. Your "basis" is reduced by that amount each year. If for some reason (I don't know of ANY good reasons) you don't take the depreciation, your basis still goes down. When you sell, the gain on the sale is the sales price, less selling costs and then you subtract your basis. Even if you're actually selling at a loss, you may have a gain because the basis is going down.

Now, the gain gets divided into two parts. First, the amount of gain up to the amount of depreciation taken (or allowed, if that's more) is subject to the tax on unrecaptured depreciation. Currently 25%. Any remaining gain is capital gains. You shouldn't have any of that.

You were allowed to take about $50K in depreciation for those 10 years. I'd guess you had maybe $3000 in costs on the purchase, so your basis would be about $123K. If you sell for $160K and have $13K in selling costs, you would have a taxable gain of about $24K for a tax of about $6,000.

Now, if you were generating passive losses from the rental as you did your taxes each year, then those carry forward. You can subtract that carry forward loss from the gain on the sale. That may help reduce your tax on the sale.

Thanks for the explanation @Jon Holdman , would you also be responsible for the recapture tax if you short sold your rental property?

What are investors doing to minimize paying the recapture tax?

  • 1031 exchange?
  • Converting rentals into primary residence?
  • Never selling the property? lol, I heard that if you pass away, your beneficially doesn't have to pay the recapture tax.
Originally posted by @Bruce L. :

What are investors doing to minimize paying the recapture tax?

  • 1031 exchange?
  • Converting rentals into primary residence?
  • Never selling the property? lol, I heard that if you pass away, your beneficially doesn't have to pay the recapture tax.

Hi Bruce,

1031 Exchange - The 1031 Exchange will defer your depreciation recapture tax, capital gain tax and Medicare Surcharge (Obamacare Tax) if you satisfy the reinvestment requirements.

Converting Rentals - Converting rental property into your primary residence can help some, but the gain will be allocated between the number of years that you held the property as rental property (and therefore be taxable) and the number of years that you lived in it as your primary residence (and therefore tax-free up to the limit of $250K/$500K). This applies when the property was a rental property first and then converted into your primary residence.

Never Selling - yes, the heirs who inherit the property will completely avoid the taxes provided they qualify for the step-up in cost basis. This is permitted because the value of the property is included in the estate computation for estate tax purposes, so it's cost basis is therefore stepped up to the fair market value at the date of death.

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