What is depreciation recapture?

Question

Jon Holdman · Answer

A little confusion here:

In this example, with the basis being $29K ($39K purchase less $10K depreciation) and a sale price of $50K the gain on the sale is $21K, not $11K.  This gain is split into two parts.  First is the $10K of "unrecaptured depreciation".  That's taxed as ordinary income, though capped at 25%.  The remainder of $11K is taxed as capital gains.

This example neglects purchase costs (add to basis), capital improvements if any (add to basis), and selling costs (deduct from net sales price.)

So, think of depreciation as a loan from the government.  You get to deduct it while you own, reducing your taxes (maybe) but then you have to pay tax on it when you sell (though capped at 25%).  In the event that you have passive losses that you cannot use (AGI  too high, is usually why) then these passive losses carry forward and can be applied when you sell, reducing the gain.

Ian Tvardovskaya · Answer

Basically, at time of sale, you need to add depreciation back into the property's basis. Example: Basis at purchase $39,000. Held for 10 years. Depreciation table is 39 years. Yearly depreciation is $1,000 per year. Sold for $50,000.

Your basis in the property at the time of sale is: $29,000 ($39,000 - $10,000). Gain is sale is $11,000. ($50,000 - $2,000).

This gain gets put into a complicated accounting provision called §1231 and comes out as long-term capital gains or an ordinary loss. Problem is you have been taking a $10,000 depreciation against your ordinary income for the last 10 years and IRS won't let you now take the entire gain at a lower tax.

The result, you must recapture the $10,000 depreciation and it will be taxed as ordinary income. The remaining gain, here $1,000, will go into that complicated §1231 analysis.

A buy and hold strategy will encounter this the most because they are actively taking depreciation on the property.

Johnny Hastings · Answer

A quick google search turned up this.

Essentially, when you depreciate an asset (which you do with real property (rental real estate for instance) and attached non-real property (appliances and such) every year on your income taxes), you've offset your taxable income. You can do this for a certain number of years, dependent upon the type of property. When you sell that asset, you have to pay back the taxes you offset over the years of ownership. The sale of that depreciated asset is where the 1031 exchange comes in, to further offset that tax. You essentially swap the depreciated asset for a new asset or assets, using the money that you would have paid in taxes to make the new purchase. Then you depreciate the new asset, rinse and repeat! If you ever decide you want to walk away with cash in your pocket from the sale of an asset, you have to bite the bullet and pay the taxes.

Scott W. · Answer

I will make it as simplified as possible since you seem like a newb. depreciation is an interest free loan from the govt until you sell. like those mentioned above, there are exceptions, etc.

but it is definitely not a bitch!

Paul Allen · Answer

Residential real property (section 1250) is depreciated in a straight line over 27.5 years. Commercial real property is depreciated in a straight line over 39 years.

Residential real property 'recapture' (a.k.a. unrecaptured section 1250 gain) is taxed at a max rate of 25%, which may or may not correlate to the taxpayer's top marginal (regular) income tax rate rate.

Dave Toelkes · Answer

@Megan Clancy

Here is a post I wrote many years ago.  Although dated, it may answer your question

https://www.biggerpockets.com/forums/104/topics/25595-how-depreciation-is-recaptured

What is depreciation recapture?

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