Recaptured Depreciation: Why It's Important

Section 1031 of the IRS Code permits the deferral of capital gains tax on the sale of business or investment property when certain conditions are met. While this can be a powerful tax-deferral strategy, there is one significant potential tax liability that many investors don’t initially consider.

In any 1031 exchange an investor must recapture all depreciation at 25%.

Depending on how long you’ve owned your investment property, the depreciation recapture could be a bigger tax liability than the capital gains tax. As a professional who has worked with investors to help them complete 1031 exchanges for nearly fifteen years, I have personally witnessed many investors receive unexpected IRS tax bills for as much as 50% or more of the total sale profits. This is because the investor did not factor in recaptured depreciation.

While the IRS provides “safe harbor” to permit the deferral of both capital gains and depreciation recapture tax liability, this safe harbor only exists if all the rules of the 1031 exchange are followed. While a properly structured 1031 exchange usually passes IRS muster, it is important to understand all the potential liability.

When you are considering a 1031 exchange, don’t forget to factor in the depreciation recapture tax requirement when doing your net calculations.

To find out how we can help you find and close on your next 1031 exchange property or to learn more about the exchange process and our qualified intermediary services, please visit our website.