Depreciation Recapture Rental Property

When you own a rental property for more than 12 months, then the property is going to depreciate some during that time. The actual land that is used will not depreciate, but any improvements that have been made to the land will. This typically means the house that is being used for a rental or the apartment complex, but outbuildings may be included in this formula. Depreciation recapture on a rental property occurs when you sell the property after claiming at least one year on the property's depreciation schedule.

Why Do You Need To Know Your Depreciation Recapture?

Let's say that you've purchased a rental property 10 years ago for $200k. Over those ten years, you've had to depreciate the purchasing costs, improvements, and other items based on their specific depreciation schedule. Now you've decided to sell that property and you get $300k for it. This is where the depreciation recapture is going to hurt your bottom line.

Most people would say you made $100k on your investment in total because you sold at $300k after purchasing at $200k. Under taxation codes, you've actually made a lot more money. The property is going to have about $5,400 in depreciation that you've claimed every year for the last 10 years. Your $200k investment for tax purposes is now suddenly worth less than $150k.

Now it starts to get complicated.

Depreciation Recapture Is a Separate Tax Rate From Capital Gains

In a simple world, you'd pay the capital gains tax on the money you made from the investment and call it a day. In the real world, you're going to have to pay a higher tax on the depreciation amount that you've been able to recapture because you're getting income on what was claimed as depreciation. That extra $54k that you made on your sale through depreciation, under current codes, is going to be taxed at 25%. The remainder of the $100k in profit will be taxed at the lower rates.

This begs a question: is it possible to reduce your depreciation liabilities? The best way to do this would be to have the property value reappraised. The land value typically remains static, but if the value of the property improvements of your rental goes down for taxation purposes, then your depreciation recapture liabilities will go down as well. Otherwise depreciation is going to happen whether you want it to or not.

If your plan is to eventually sell your rental property, then it is important to budget for depreciation recapture ahead of time so you aren't surprised by the amount of taxes that are headed your way after you make a sale. The good news is that you'll still have made money on your rental property. If you're careful and plan ahead, you'll pay the right amount and not destroy your budget or put yourself at risk for fines and penalties because of inaccurate information being filed.
Posted on Oct 08, 2014


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