Depreciation Recapture Tax

2 Replies

What is the best way to delay or avoid paying depreciation recapture tax? It is my understanding that when you sell a property, you are required to pay back all of your accumulated depreciation at a rate of up to 25%. If you do a 1031 exchange that will delay the tax. If you pass it on as an inheritance at your death, your heirs will be able to start a new cost basis. Does that include deprecation expense? If the property is in an LLC, would the heirs be eligible for the new cost basis? or would the entity have to pay that tax? How are most of you dealing with this hefty tax on a sale?

@Matthew S.  ,  I've heard CPAs speak of setting up two depreciation schedules - one that continues the deceased's schedule, and one for the additional step up in basis from inheritance.

But the more conventional method is to use the step up basis as a brand new adjusted cost basis and the heir begins a new single depreciation schedule.  Certainly this eliminates depreciation recapture but not for you only your heirs.  And you'll still have to pay attention to estate limitations in place.

You may also look into a Charitable Remainder Trust as a method of accessing profit while avoiding capital gains tax and depreciation recapture.

Regarding the LLC it will depend on how it has elected to be treated tax wise. Look at the opportunities afforded you in a 754 election.

Great question and well worth an hour or two of your CPA's time.

@Matthew S.  

The capital gain and depreciation recapture taxes are all deferred indefinitely as long as you keep structuring 1031 Exchanges, and as you pointed out, the capital gain and depreciation recapture taxes all go away at death due to the step-up in cost basis.  You most likely will also avoid the Medicare Surcharge (Obamacare tax) via the 1031 Exchange as well.

LLC's can complicate the issue because the heirs are not inheriting property but actually inheriting the membership interest in the LLC. There are a number of issues here, so have your tax advisors review to determine how it would be accounted for at death.

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