Depreciation recapture in this situation?

5 Replies

My son and I were having a real estate discussion this afternoon, and came up with a question that we weren't sure how to answer.

If you have a rental house that is fully depreciated, and is then destroyed - natural disaster, fire, bulldozer, whatever - and then the land is sold, is the depreciation recaptured? Does the amount of time between the destruction and the land sale make a difference?

Originally posted by @Sylvia B. :

My son and I were having a real estate discussion this afternoon, and came up with a question that we weren't sure how to answer.

If you have a rental house that is fully depreciated, and is then destroyed - natural disaster, fire, bulldozer, whatever - and then the land is sold, is the depreciation recaptured? Does the amount of time between the destruction and the land sale make a difference?

There is no depreciation recapture if there is no gain. You have not shared any no# detail to know that. 

When you have an event like that, you need to factor in insurance proceeds and other factors to determine your gain. 

If you still want to be in the RE game, you can acquire another property that is wither like-kind or similar use ( two tests under sec 1033) and defers gain and the recapture. Its called involuntary conversion. Google it. 

@Sylvia B.

What you're describing is a involuntary conversion. The event removes the building from your balance sheet and a gain or loss is calculated. In your example the FMV after conversion is $0 and the tax basis in the building is $0 so there's neither gain nor loss, although in reality most people will receive insurance proceeds and may have a gain.

The land is a non-depreciable asset, there's no 1250 gain associated.

If you have demolition or removal costs associated with the rubble, those get absorbed into the land basis under IRC Sec 280B.

No depreciation recapture with no gain? Hmm. This is a completely hypothetical situation, so let me make up some numbers to consider, in 2 different scenarios.

1) Purchase price $50,000, 10 of that allocated to the land. 30 years later, fire destroys the building and the insurance pays out $50,000. The land is now considerably more valuable than when it was purchased, so you decide to sell instead of rebuilding. You get $100,000 after all selling costs are paid.

What is your gain, and is there depreciation recapture?

2) Purchase price $50,000, 10 of that allocated to the land. 30 years later, after allowing the building to deteriorate instead of maintaining it, you decide that you no longer want it to be a rental. You bulldoze the building, keeping the land. 2 years later you are offered $150,000 for the land, so you sell.

What is your gain, and is there depreciation recapture?

@Sylvia B.

"No depreciation recapture with no gain?"

Based on your the face value of the facts in your OP, yes.  However -- again -- most investors would receive insurance proceeds in the event of a causality loss.  In the event the property is full depreciated, generally they would recognize gain and that gain may be 1250 gain.

The gain may be able to be deferred by reinvesting the proceeds.  This is a pretty complicated area and if it's anything more than a hypothetical I'd encourage you to work with a professional.