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I've always been told that depreciation recapture on real estate is a flat 25% rate. I am trying to verify this with IRS publications and I cannot. Does anyone have any input? Thanks in advance.
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This is an interesting question. I always thought that depreciation recapture would be at the capital gains rate in the year that I sell the property, and that I would pay the same capital gains rate on real estate sold as I would on any other investment subject to capital gains taxes. So for me as a high earner, 20% plus the extra 3.8% for a total of 23.8% federal capital gains tax, not to mention the state tax.
I own a lot of highly appreciated real estate that has been or is being depreciated. The substantial capital gains tax makes it very disadvantageous to sell. My only way around this would be to do a 1031 exchange into a new property when selling the original property to defer the capital gains, or to keep the property until I die and then pass it to the heirs at a stepped up basis not subject to capital gains taxes.
Even if I do the inheritance thing, however, if I have enough property and assets the property will still be subject to estate taxes. The amount of the estate tax exemption has increased for 2018, but this will likely change in the future. -
25% rate, though this stuff is pretty messy.
https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/property-basis-sale-of-home-etc-5Comment
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Yes, depreciation on real estate is recaptured at 25%.My passion is protecting clients and others from predatory and ignorant advisors 270-247-6087 for CPA clients (we are Flat Fee for both CPA & Fee-Only Financial Planning)
Johanna Fox, CPA, CFP is affiliated with Wrenne Financial for financial planning clientsComment
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Carryover passive losses have no interaction with depreciation recapture, but can be used to offset capital gains at the time of sale, correct?Comment
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Depreciation recapture is at 25%, up to your basis. Above your basis it is taxed as ordinary income.
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This is why 1031 exchanges are so popular. Much more attractive to roll it over into another property and avoid significant tax liabilities. Ultimately you can leave it to your heirs on a step up basis. Even if at that point it triggers the estate tax, I'd still delay paying Uncle Sam for as long as possible. Obviously this depends on your exact scenario, but 1031s are one of the biggest tax advantage moves one can make, and help make real estate such an attractive investment vehicle. Use the depreciation to offset most of your annual income from the investment, then roll the proceeds over in a 1031 to avoid having to pay the recapture when you sell. Rinse, Repeat.Comment
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Yes, depreciation on real estate is recaptured at 25%.
Thanks for your reply. Where can I verify this on an IRS publication or form?Comment
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Yes 25% up to the original basis. That is why high in come earners this wins by nearly 10 percent over time and compounded earnings on those funds if you sell.
Still better is 1031 exchange within the year. Fund your 2nd home / retirement beach front property with those funds.Comment
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Depreciation recapture is at 25%, up to your basis. Above your basis it is taxed as ordinary income.
Pardon my ignorance, but how could you have depreciation above your basis? That does not seem possible.Comment
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Yes 25% up to the original basis. That is why high in come earners this wins by nearly 10 percent over time and compounded earnings on those funds if you sell.
Still better is 1031 exchange within the year. Fund your 2nd home / retirement beach front property with those funds.
I'm dealing with a situation where a 1031 exchange is not ideal. Do you know where I can verify that it's 25%? I'm a "trust but verify" type of guy.
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This is why 1031 exchanges are so popular. Much more attractive to roll it over into another property and avoid significant tax liabilities. Ultimately you can leave it to your heirs on a step up basis. Even if at that point it triggers the estate tax, I’d still delay paying Uncle Sam for as long as possible. Obviously this depends on your exact scenario, but 1031s are one of the biggest tax advantage moves one can make, and help make real estate such an attractive investment vehicle. Use the depreciation to offset most of your annual income from the investment, then roll the proceeds over in a 1031 to avoid having to pay the recapture when you sell. Rinse, Repeat.
I don't disagree at all. But sometimes 1031 exchanges are not possible due to their limitations and guidelines. So I'm trying to verify how depreciation recapture works. And it's been more difficult than I expected. The opinions on the web (including this forum) vary pretty significantly.Comment
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25% rate, though this stuff is pretty messy.
https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/property-basis-sale-of-home-etc-5
Thank you for the link. I noticed this is an FAQ that deals with a primary residence. Further, it says that the gain "may be" subject to the 25% rate. Which seems to imply that it may not. So I'm not sure this link answers my original question, but I appreciate it nonetheless.
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Time to partner with a CPA.Comment
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