Is it possible to minimize taxes on depreciation recapture?

3 Replies

Let's say you have 1 rental and no other type of income.

Rents after mtg interest, Property taxes and insurance brings income to under 9k and therefore no taxes are owed in this situation. No other expenses for this example.

You then have to include depreciation, but it provides no tax benefit. Depreciation does not create a loss.

This happens year after year for many years.

So in this case depreciation seems to only hurt since it adds up year after year until the property is sold and then you pay taxes on this accumulated depreciation if there is any profit from the sale, but it does nothing to help pay less taxes year after year since income is low anyway whether you include depreciation or not.

Since depreciation is mandatory to include regardless if it helps you or not lower your tax liability, Is there a way to minimize the taxes paid on this depreciation recapture at the time of sale assuming there would be profit?

Trying to find something positive from this scenario.

Insight on this is appreciated and please correct me if I am wrong too.

Thank you. 

@Dan Earl Yes! If you are selling a rental property and have the intention of purchasing another, a 1031 Exchange may be a perfect solution for you. Section 1031 of the Internal Revenue Code allows you to defer any gain and depreciation recapture liability. There are requirements you must follow to have a successful 1031 exchange but they are fairly simple and the process can be stress-free is you enlist the help of a reliable and experienced Qualified Intermediary. You would need to set up an account with a QI prior to closing on the sale, you are unable to take receipt of the funds, then you have 45 days to identify your replacement property or properties using a specific identification rule, and then another 135 days to close on one or all of those properties. Your goal would be to trade equal or up in value from your net sales price. This can be a wonderful estate planning tool as well. If you continually do 1031 exchanges when you sell your rental properties, eventually when you pass away (not fun to think about) your heirs are not responsible for paying back the depreciation and tax you've deferred. Please let me know if you would like to discuss your particular transaction in more detail.

@Dan Earl

I'm not a CPA, and I haven't done this personally, but If you were to make the property your primary residence for 2 out of the past 5 years at time of sale, you would be able to avoid capital gains of 250k if you are filing single or 500k if you are filing married.

Any CPA's or people smarter than me know otherwise?

Originally posted by @Matt Leonard :

@Dan Earl

I'm not a CPA, and I haven't done this personally, but If you were to make the property your primary residence for 2 out of the past 5 years at time of sale, you would be able to avoid capital gains of 250k if you are filing single or 500k if you are filing married.

Any CPA's or people smarter than me know otherwise?

Unrecaptured section 1250 gains (sometimes known as 'recaptured depreciation') are not excluded from income under the section 121 provision allowing exclusion of capital gains on the sale of a primary residence.

For Dan - the taxes on the depreciation recapture are UP TO 25%. People in a low income tax bracket can have a 0% tax rate on the depreciation recapture. (We rarely talk about this because most real estate investors end up paying 25%.) You should get with a tax pro and run the actual numbers to see what your tax implications are on the sale.

Or, if you really want your brain to hurt, you can use this handy worksheet to figure it out. (You have to carry the result forward to line 33 of the next worksheet, as well.)

Best of luck with your real estate investing!

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