Here’s 8 surprising things about depreciation recapture.
Because here’s the problem: When you own rental property, you will be taking depreciation on your tax return. It’s a tax write off. But when you take depreciation, you need to recapture it when you sell the property.
And real quick, a 1031 exchange is when you sell one rental property and buy another one according to the IRS rules and timelines.
This enables you to postpone or defer taxes, sometimes forever, and thus you can build generational wealth for your family just like the big investors do.
1031 Exchange Depreciation Recapture: Eight things you didn’t know.
1. What is Depreciation?
Depreciation is an accounting term when used in a 1031 exchange. So what is it?
On your taxes, when calculating depreciation with a rental property, you take the Improvements, like the building, for instance, and there are certain limits on what you can depreciate each year. In the case of residential, you can depreciate over 27.5 years. What does that mean? It means that you can actually take a percentage of the value of the improvements off your taxes every single year. This saves you taxes on your ordinary income.
2. How to Calculate Depreciation?
In the case of a residential property, you take the value of the improvements and divide by 27.5 years. Each year you can depreciate or deduct that amount off your taxes.
3. What if you didn’t deduct depreciation?
What if you forgot or you didn’t think it was important or whatever? The depreciation they consider is the amount that you actually took or were permitted to take each year. So you do want to take your depreciation.
4. Why do you need to recapture depreciation?
Well, you deducted it off of your taxes against your ordinary income. And if your ordinary income is pretty high, then you got a fairly substantial deduction off what you would have paid.
Now when you sell your property, you recapture the depreciation because you give it back to the government. Or, you give it back to the IRS, or you give it back in your taxes, whatever you want to call it.
The government wants it back when you sell it.
5. Is depreciation recapture the same as capital gains tax?
No, it isn’t. It is completely different because you can get capital gains on a variety of items from personal property to your personal residence to something else that you sell. Depreciation is on a rental property and once you’ve taken the depreciation and then you sell the property, the government or the IRS says, we want to recapture some of your benefits. If you’ve taken depreciation or you were allowed to take it on the improvements on a rental property, when you sell that property, you will recapture it.
You will pay some of that back. Capital gains tax, when you sell a property, it will be a whole different calculation because it’ll be based on whether you made a profit or that you had a gain from your original basis in the property to when you sold it.
6. How to calculate depreciation recapture tax?
First, you have to know how much your property depreciation was – how much you were entitled to or how much you took. Even if you didn’t take depreciation on your income property, you calculate it based on the depreciation you did take or could have taken. The amount that you were entitled to.
7. How to avoid depreciation recapture tax?
Well, you can postpone, defer, or avoid depreciation recapture tax by doing a 1031 Exchange. And, as you know, you can also defer, maybe forever, other taxes that are related to your investment property when you sell them, of course, using a 1031 exchange.
8. What’s the current maximum rate for depreciation recapture?
It’s 25%. Which is really sort of neat if you think about it because you probably were paying a much higher rate for your ordinary taxes and you were able to offset ordinary taxes by your depreciation.
Oh, and if we haven’t yet met, my name is Maxine Golden. I’m a long time real estate broker, and I started the 1031 Exchange Lady channel because I believe that you deserve the same tax breaks as the big investor. The law says you do, and you do.
But don’t take my word for it. Talk to your accountant or ask the IRS. They will tell you the same thing.
So I specialize in helping property owners like yourself across America do a 1031 exchange or find an experienced agent to help them with their exchange.
So you can ask me your questions in the comments below or see below to book a call. I look forward to seeing you in the next video.