Is it just me or does depreciation recapture and capital gains make real estate seem less lucrative or attractive than it used to? I'm not to keep on losing 40% of my hard work to the government. I know 1031's are an option but how do you ever realize your profits if the result is a 25 - 40% loss of the gain? Pretty disappointing.
Remember, the recapture tax, while paid all at once, is actually a repayment of the deduction/taxes you saved over the life of the property...essentially an interest free loan, not really an additional tax at all.
So if I owned a $100k property and it depreciated $10k over 4 years and I sold it for $100k I would be taxed $10k capital gain and also add the $10k of depreciation to my normal income tax?
If not can you give an example of how it would work?
If you "broke even", $100k vs$100k, there would be no gain. You would pay $2500 on the depreciation that you deducted over those 4 years.
Just to add to Wayne's comment.
Over the four year holding period, the depreciation you took reduced your taxable rental income by $10K. If you were in the 25% tax bracket, this saved you $2500 in taxes. If you sold the property in your example for $100K, you are saying the depreciation never happened. The unrecaptured depreciation tax is Congress' way of having you pay the taxes you avoided in the first place for deprecation that really never occurred..
Originally posted by @Ian McDonald :
,... I know 1031's are an option but how do you ever realize your profits if the result is a 25 - 40% loss of the gain? Pretty disappointing.
@Dave Toelkes and @Wayne Brooks covered the tax impact. I'll give you an answer to the snippet that is in the quote.
After the 1031 exchange has completed, you will hold the replacement property for say a year, then you do a cash out refinance on the replacement property. You don't realize the profits as profits; instead you get a loan based on the higher value, and tax treatment of loan proceeds is very favorable ;)
My take is a little different from Steve's.
Buy and hold investors don't realize profits because they never intend to sell. Buy and hold investors aren't buying a rental property, they are buying a cash flow. A 1031 hopefully helps you increase your cash flow while (indefinitely) deferring capital gains taxes.