Last updated on June 23rd, 2021 at 05:45 pm
Depreciation recapture calculator | How depreciation recapture works | Depreciation recapture tax rates | How to avoid depreciation recapture | Depreciation recapture example | Depreciation recapture FAQs
Depreciation recapture, a provision the IRS uses to tax the profitable sale of a rental property on which the owner has previously claimed depreciation, can have a great impact on an investor’s bottom line.
To determine the amount you’ll be taxed on your depreciation recapture, use our depreciation recapture tax calculator. All you need to do is input basic information like your property’s purchase and sale prices, how long you’ve owned it, and how much annual depreciation you claimed.
Crunch your numbers below with the depreciation tax calculator, or skip ahead for a deeper dive into the details of depreciation recapture.
Depreciation Recapture Calculator
Plug in the basic information requested for each field to learn how much you’ll owe without deferring your gains.
How does depreciation recapture work?
It’s hard to explain depreciation recapture without touching on depreciation itself, so let’s start there.
As you probably know, depreciation is a tax deduction that reflects the costs of owning and improving a property. The IRS considers the “useful life” of a rental property to be 27.5 years, so the amount of depreciation you can claim each year is your property’s value divided by 27.5.
This is a coveted tax deduction because depreciation isn’t a real cash expense. But since it reduces your tax rate, it effectively improves your cash flow.
However, it’s not a free ride. By taking depreciation, you’re essentially telling the IRS that your property is worth less and less each year. If you sell the property for more than you bought it for, the IRS is going to feel like you’ve gotten a free tax write-off, and it’ll want to recapture — or tax — some of that depreciation.
Investors often dread depreciation recapture tax because it’s a tax on savings they’ve enjoyed in the past, not on money they’ve recently made.
Depreciation recapture tax rates
Since depreciation recapture is taxed as ordinary income as opposed to capital gains, your depreciation recapture tax rate is going to be your income tax rate, with a cap at 25%.
This 25% cap was instituted in 2013. Previously, the cap was 15%.
Your depreciation recapture tax rate will break down like this:Shortcode
Remember, your depreciation recapture tax rate is determined by what income tax bracket you’re in.
To learn more about the taxes you’ll potentially face and to chart a path forward, consult with an experienced expert. Contact us today and we’ll put you in touch with a seasoned qualified intermediary.
How to avoid depreciation recapture
The most effective way to avoid depreciation recapture is to use a 1031 exchange.
A 1031 exchange allows you to avoid depreciation recapture for the same reason it allows you to avoid capital gains taxes. In the eyes of the IRS, you’re trading the property, not selling it. Therefore, there’s no financial gain to tax.
In reality, avoiding tax means you’re only delaying your tax bill, not eliminating it. But since there’s no limit on how many times you can use a 1031 exchange, many investors use them to defer depreciation recapture indefinitely.
» LEARN MORE: Read How to Avoid Depreciation Recapture Tax on Rental Property
Depreciation recapture example
Let’s look at an example to illustrate depreciation recapture in the real world.
An investor buys a duplex for $500,000 building value. (It’s “building value” because land can’t be depreciated.)
The investor takes $30,000 depreciation each year for ten years. Total amount of depreciation taken: $300,000. That means the property’s adjusted cost basis is $200,000 — the purchase price minus the total depreciation taken.
After some time the investor sells the duplex for $750,000. The investor’s realized gain: $550,000 — the sale price minus the purchase price.
So how are taxes assessed on that realized gain? Well, this is where depreciation recapture comes up. Since this investor claimed a total of $300,000 in depreciation over the years, $300,000 of their realized gain gets taxed at the depreciation recapture rate, which is capped at 25%.
The remaining $250,000 of the realized gain gets taxed at the investor’s capital gains tax rate of 20%.
In this scenario, the investor pays $75,000 in depreciation recapture (25% of $300,000), and $50,000 in capital gains taxes (20% of $250,000).
While most investors are more concerned about capital gains, this example shows how depreciation recapture can account for much more of an investor’s tax bill than capital gains.
That’s the power — and the pain — of depreciation recapture.
|🤙 GET 1031 EXCHANGE ASSISTANCE: To learn more about using a 1031 exchange to help address potential depreciation recapture, consult with an experienced expert. Contact us today.|
Depreciation Recapture FAQs
Let’s answer some of the most common questions about depreciation recapture.
Can I avoid depreciation recapture on rental property taxes by moving into my rental property?
You can delay them with this strategy, but you can’t avoid them indefinitely.
Also keep in mind that while you’re able to do a 1031 exchange with a property you lived in, only the non-qualifying use portion of your ownership — the years you didn’t not live in the property, and used it as a rental — is eligible for tax deferral.
What is Section 1250 depreciation recapture?
Section 1250 is a provision in the IRS code that taxes previously recognized depreciation as income instead of long-term capital gains.
Let’s say you bought an investment property and sold it after a decade for a nice profit. Once you calculate your cost basis, the net gain from the sale will be split up into unrecaptured 1250 gains (the amount of depreciation you claimed during your ownership), and conventional capital gains. Those two portions will be taxed at different rates.
Will I owe depreciation recapture on my primary residence?
You won’t owe depreciation recapture on your primary residence — unless you took deductions on it as a home office.
How is depreciation calculated?
The most common method of calculated depreciation — the General Depreciation System — spreads depreciation equally over a term of 27.5 years for residential buildings.
To calculate your depreciation, divide your property value by 27.5, and you get the amount of depreciation you’re allowed to claim each year.
For commercial buildings, the term is 39 years.
Will I owe depreciation recapture on rental property if it’s gifted?
While gifting a property confers some tax advantages, any depreciation claimed on that property will still be subject to recapture when it’s sold, since the adjusted cost basis is unchanged.
What is bonus depreciation recapture?
Bonus depreciation is a temporary tax provision (currently scheduled to phase out by 2027) that lets you speed up the depreciation you could claim over the life of a property. You can claim more of it now.
If you claim bonus depreciation on a property, and then sell it for a gain, that bonus depreciation will be taxed as ordinary income, and not capital gains. That’s bonus depreciation recapture.
Is bonus depreciation subject to recapture?
Yes. While bonus depreciation has become a popular tool for real estate investors, especially since it applies to both new and used property, it’s definitely subject to recapture.
However, there are ways to avoid bonus depreciation recapture. You can reclassify your property as personal property, and then use the section 179 exclusion. Or you can use a 1031 exchange to defer depreciation recapture taxes.
Read more about these strategies, and others, in our article about bonus depreciation recapture.