I am about to sell a rental 3-unit property that has had a good bit of depreciation of my purchase price + the depreciation of the improvements I added, new appliances etc.
When I sell the property I am I responsible for paying the depreciation recapture on just the depreciated value of the original purchase price or also the annual depreciation on the improvements I made on the purchase. And if it is both is there anyway to avoid the latter?
The buyer isn't doing any type of cost segregation.
@Gonzalo Escobar you will pay taxes on the gain you have offset by the depreciation for both the real estate and the improvements. Whether or not the buyer does any cost segregation has no effect on your tax liability. Before selling you should consult a CPA and possibly consider a 1031 exchange.
You pay depreciation recapture, on all depreciation taken over the life of the investment, in the year of the sale (regardless of whether you owner finance) at a 25% rate. So yes, original improvement value of the home plus any improvements you made.
You cannot "avoid" these taxes, however you can defer them via a 1031 exchange. Whether or not that makes sense for you will be dependent on your current and projected financial and tax position.
Would then the undepreciated value of the improvements be added to the basis, so for example.
Property is 100k, 10k Depreciated, Improvements are 100k, 10k depreciated.
If I was to sell for 180 would there be no capital gain?
You are correct in this example. I'd suggest linking up with a real estate savvy CPA prior to the sale to make sure you have your exit strategy down and understand all tax implications that come with it.
You would be responsible for the taxes on the whole amount. I think you're best option is definitely to do a 1031 exchange.
There is a potential tax trap with 1031 exchanges that many people fail to take into account, especially if you exchange a property several times. You may end up owning a property with very little basis that is worth a very large amount of money (an apartment building perhaps?). What happens if that property no longer fits your portfolio and you wish to sell it? There may no longer be very many choices of properties available that you would want to exchange into when you want to. You would then be faced with writing a very large check to the IRS if you sell or, more likely, be stuck in a property you don't want. Your heirs will get a windfall if they inherit but that may not have been your intention.
I would tend to disagree with your outlook on 1031 Exchanges. While your scenerio is a possibility, it is not the only possibility. One of the beauties of 1031 Exchange is that it allows you to diversify your real estate portfolio both geographically and property types. Therefore, if "your property" no longer fits your portfolio, you are able to sell that one property and purchase several (perhaps smaller ones) investment properties in various forms, meaning single family, duplex, commercial, industrial, etc. You are able to diversify your portfolio and avoid paying that large check to the IRS Plus, at your death, your heirs will inherit the property at the stepped up cost basis (eliminating the original low cost basis on the original property)
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