How to calculate depreciation and tax burden

Question

I am having some issues figuring out to calculate how depreciation affects my tax for a rental property. I have an example below. Is it correctly calculated correctly?

Example:

• Purchase price: $1,500,000
• Rehab: $100,000
• Land Value: $750,000
• Year 1 interest paid: $41,632
• Year 1 principal paid: $23,029
• Yearly property tax: $18,750
• Annual expenses: $6,200 (Insurance, utilities, gardener, and so on)
• Tax rate: 25%
• The annual rent income is $129,600

$1,500,000

$100,000

$750,000

$41,632

$23,029

$18,750

$6,200

25%

$129,600

The house value is $750,000 (purchase price - land value) + $100,000 in rehab (all just calculated as 27.5 to make it easier), depreciated over 27.5 years is $30,909 a year.

$750,000

$100,000

$30,909

If we calculate our year's profit $129,600 (rent income) + $23,029 (principal) - $6,200 (annual expenses) - $18,750 (property tax) - $41,632 (interest paid) = $86,047

$129,600 (rent income) + $23,029 (principal) - $6,200 (annual expenses) - $18,750 (property tax) - $41,632 (interest paid) = $86,047

My depreciation is $30,909 a year, I can subtract that from my taxable income. $86,047 - $30,909 = $55,138 I am then taxed on the $55,138 at 25% making this year's tax $13,784.5 That would mean my annual profit is $86,047 - $13,784.5 = $72,262.5 and cash flow $72,262.5 - $23,029 = $49,233.5

$30,909

$86,047 - $30,909 = $55,138

$55,138

$13,784.5

$86,047 - $13,784.5 = $72,262.5

$72,262.5 - $23,029 = $49,233.5

Is this correct so far?

Let's say that I hold the property for 10 years and sell it for $1,950,000., meaning that I increase the value of the property by $450,000. And the land value was 50% meaning that the building has increased the value by $225,000.

$1,950,000

$450,000

50%

$225,000

How do I calculate how the depreciation recapture is taken at this sale?

Dave Toelkes · Answer

@Kasper Rune Søgaard

First, let's get the terminology correct. You don't have profit until you sell the property. You have net rental income which is also called cashflow, and, you have net taxable income.

To calculate your net rental income, or annual cashflow. start with your gross rental income then subtract your out of pocket costs of ownership and rental operation (principal payments, mortgage interest, property taxes, hazard insurance, and other expenses) to get $39,989 using your numbers.

Your taxable income before depreciation takes your cash flow and adds back your principal payments to get $63,018. Subtract your depreciation expense to get your net taxable income of $32,109. In the 25% bracket, the tax on your net taxable rental income would be $8027.

If you take a $30,909 depreciation expense each year for 10 years prior to sale, you would pay a 25% depreciation recapture tax on the $309,090 allowed depreciation in addition to the long term capital gains tax on $350,000 profit due to appreciation. Don't forget that the increase in your land value is also subject to capital gains tax when you sell the property.

Ashish Acharya · Answer

Your numbers look ok except you cannot deduct the 1st year principle paid.

For recapture, you need to add all the depreciation you have taken over the years. if your gain is at least as much as equal to the gain (Saleprice- adjusted basis- expenses), you will pay the 1250 unrecaptured depreciation at the max rate of 25%.

If you need more detailed analysis, feel free to reach out. More than happy to help.

Kasper Rune Søgaard · Answer

I am pretty sure that you need to pay taxes on the money used to pay down the principal?

Christopher Smith · Answer

If I'm seeing this correctly, principal pay down does not become part of your taxable income calculation.

Depreciation recapture in this case would simply be the accumulated depreciation at the time of sale. You would likely have additional gain above and beyond the recapture component.

How to calculate depreciation and tax burden

How to calculate depreciation and tax burden

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