How does depreciation recapture work?

Question

I've heard a lot about the benefits of depreciation and forcing as much into it when you first buy the property, but how does depreciation recapture work and is it something that most investors ignore because they plan on doing a 1031 exchange?

Are flippers worried about it?

Bill B. · Answer

That financial planner should have any certifications taken away and their clients warned. Either they are “teaching” clients about something they don’t have a clue about or they are out right lying in a way that will cost their clients thousands of dollars.

You have to pay depreciation recapture even if you never claimed it. You are literally giving money away.

Michael Plaks · Answer

In short , depreciation is a loan: you take it during the years of ownership and then return when you sell, known as recapture.

Most investors do ignore it, simply because they have never heard of it.

You're right: a 1031 exchange pushes depreciation recapture into the future, just like capital gain.

Depreciation does not apply to flippers, and neither does depreciation recapture. Flippers have enough tax headaches as is.

Natalie Kolodij · Answer

You've been reporting deprecation for years on the rental, that accumulates and is tracked.

So when it sells it's part of the calculation on your tax return.

Bill B. · Answer

If those numbers are all net. MOST, if not all, people are taxed 25% on the depreciation recapture (the $50k you depreciated) and then the other $100k ($200k - $100k) is taxed at your capital gains rate. (OFTEN around 15%)

So about $27,500 in taxes due...

Kyle Kadish · Answer

@Anthony Blasko. 50k would be subject to depreciation recapture, 100k subject to capital gains.

Kyle Kadish · Answer

@Anthony Blasko. A property was purchased for 100k.  Over life of property, owner fully depreciated.  Property is sold for 300k, exchanged, and replacement purchased for 400k.  Owner can only depreciate 100k of new property (400k-300k).

Greg Bishop · Answer

Thanks Natalie. I'm glad I'm getting good advice from my accountant!

Kyle Kadish · Answer

When conducting a 1031 exchange, you carry the basis.  You do not get to depreciate the full value of the replacement property, only any depreciable amount left from what was sold and the increased value from the replacement(s).

Michael Plaks · Answer

Usually it does not matter, but in some cases it might.

Example:

Property bought for $200k, of which $50k was land and $150k was the building. Years later, half of the building ($75k) was depreciated. Normally, it would be recaptured at sale.

Now, let's say the property is being sold for $400k. However, the land appreciated so much that it is valued at $325k now. Only $75k is left for the building. Guess what? There would be no depreciation recapture, because the building is sold for $75k which is equal to its current ("adjusted") tax basis.

This is a rare scenario, but it does illustrate that land appreciation can have interesting tax consequences.

Natalie Kolodij · Answer

Land is not depreciated. Only buildings/ Improvements.

How does depreciation recapture work?

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