How Do Depreciation Schedules Work

Question

I was discussing depreciation schedules as a benefit for real estate investors over the weekend. The person I was speaking with seemed to think that the write off involved with a depreciation schedule would be due upon sale of the property. Is that true or is depreciating a rental property a true write off?

Natalie Kolodij · Answer

Depreciation schedules is the name of the actual form generated in the tax return that shows how much depreciation will be taken/ has been taken each year/ starting basis and date put in service.

You MUST depreciation a rental property. If it's residential it's over 27.5 years straight line depreciation.

When you sell there is a recapture tax based on that depreciation taken. This comes into play with a property is sold for a gain.

So if you owned a property for 15 years, and over that time took depreciation of $100k - Then $100k of your gain will be taxed at up to 25% rate as depreciation recapture separately from the normal capital gain tax rate on the rest.

Paul Caputo · Answer

@Josh Wallace The depreciation schedule (usually called a Tax Asset Detail, Fixed Asset Schedule or Federal Asset Report) is just the document that shows your depreciation deductions. You don't have a choice about taking depreciation, but you can choose to either take it straight line or use accelerated depreciation.

Upon sale of a property depreciation recapture applies to the amount allowed or allowable meaning if you didn't take depreciation you will still have to pay the recapture on what you could've taken.

Here's how the numbers would look. Say you bought a property for $500k and over a number of years took $100k in depreciation. If you're at 35% tax rate that depreciation was worth $35k in tax benefits. Then you sell for $600k. That $100k depreciation is recaptured at 25% so you have to pay back $25k in recapture tax. Then you have a capital gain of $100k as well taxed at capital gains rate of 15% for $15k of capital gains tax. So you have a tax hit of $40k on that sale, but over the years you've gotten $35K in tax benefits from the property and $100k gain. If you didn't take the depreciation those numbers would be the same except no $35k in depreciation benefits.

If you think about this it makes sense. You get the depreciation deduction because you own the property. When you no longer own it you're no longer entitled to those tax benefits you took when you did own it. Also the time value of money is at play here. Since a dollar today is worth more than a dollar tomorrow the tax hit on sale is worth less in today's dollars and the tax benefits today are worth more in future dollars.

The practical way to look at depreciation is that without it your current tax bill will be higher, and with depreciation your current tax bill will be lower.

Josh Wallace · Answer

So if I follow, you would be taxed based on the GAIN of the sale of the property compared the the amount that you depreciated the property? Sorry for the confusing wording.