Depreciation Recapture
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Depreciation Recapture (by Roy [AL]) Sep 19, 2022 1:02 PM
       Depreciation Recapture (by WMH [NC]) Sep 19, 2022 1:30 PM
       Depreciation Recapture (by Jim in O C [CA]) Sep 19, 2022 2:37 PM
       Depreciation Recapture (by Roy [AL]) Sep 19, 2022 3:13 PM
       Depreciation Recapture (by Hoosier [IN]) Sep 19, 2022 4:00 PM
       Depreciation Recapture (by MikeA [TX]) Sep 19, 2022 5:31 PM
       Depreciation Recapture (by Ray-N-Pa [PA]) Sep 19, 2022 5:58 PM
       Depreciation Recapture (by 6x6 [TN]) Sep 19, 2022 8:32 PM
       Depreciation Recapture (by MMIT [VA]) Sep 19, 2022 8:50 PM
       Depreciation Recapture (by plenty [MO]) Sep 19, 2022 9:52 PM
       Depreciation Recapture (by S i d [MO]) Sep 19, 2022 10:09 PM
       Depreciation Recapture (by Roy [AL]) Sep 19, 2022 10:17 PM
       Depreciation Recapture (by S i d [MO]) Sep 19, 2022 10:21 PM
       Depreciation Recapture (by Roy [AL]) Sep 19, 2022 10:31 PM
       Depreciation Recapture (by don [PA]) Sep 20, 2022 3:06 AM
       Depreciation Recapture (by Oregon Woodsmoke [ID]) Sep 20, 2022 10:58 AM
       Depreciation Recapture (by S i d [MO]) Sep 20, 2022 11:44 AM
       Depreciation Recapture (by Heartland [NC]) Sep 21, 2022 9:54 AM
       Depreciation Recapture (by WMH [NC]) Sep 21, 2022 1:31 PM

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Depreciation Recapture (by Roy [AL]) Posted on: Sep 19, 2022 1:02 PM

Does anyone here understand the logic (if there is any) behind depreciation recapture and why it is subtracted from your cost basis when you sell? I am planning on selling one of my rental houses that has a cost basis of $23,000 and I have accumulated $13,000 in depreciation since buying the house in 2010.

I know what depreciation is,...but why does it have to be 'recaptured' when you sell?

Depreciation Recapture (by WMH [NC]) Posted on: Sep 19, 2022 1:30 PM

Because you have to pay the piper (tax man) at some point. Depreciation is a tax DEFERRAL not a tax forgiven.

Found this:

What Is Depreciation Recapture?

“Depreciation recapture” refers to the Internal Revenue Service’s (IRS) policy that an individual cannot claim a depreciation deduction for an asset (thereby reducing their income tax) and then sell it for a profit without “repaying the IRS” through income tax on that profit. By reporting the profit as ordinary income rather than as capital gains, which is taxed at a lower rate, the difference between the sale price and adjusted cost basis is “recaptured.”

Worth reading:

w w w,sale%20price%20for%20the%20asset.

Depreciation Recapture (by Jim in O C [CA]) Posted on: Sep 19, 2022 2:37 PM

If you postpone the sale until you die recapture is waived.

Depreciation Recapture (by Roy [AL]) Posted on: Sep 19, 2022 3:13 PM

Jim in OC

If I had children to inherit my rental properties, I would probably do that. Since I do not, my plan is to sell one rental house a year until I kick the bucket. I am selling the houses located in the D hoods first. Most of these house were bought for $5K and the time has come for me to cut them loose.

Depreciation Recapture (by Hoosier [IN]) Posted on: Sep 19, 2022 4:00 PM

You are getting the benefit on the front end, so you must pay on the back free lunch. It's complicated to get exact numbers, but WMH has it right in concept.

Depreciation Recapture (by MikeA [TX]) Posted on: Sep 19, 2022 5:31 PM

It's going to get worse if your friend in the White House has his way. You will be paying ordinary income rates rather than capital gains rates on all of it when you sell.

Depreciation Recapture (by Ray-N-Pa [PA]) Posted on: Sep 19, 2022 5:58 PM

Any one or anything can inherent your properties. So give them to a charity or even do a 170 bargain sale

Perhaps it might be better you placing these places into a trust and then selling just the beneficial interest instead of the real property. You get rid of the hassles and what you sell is consider personal property then

So why does the government do it in this manner? My guess and it is only a guess, since the majority of the landlords are small timers, their income can be as low as 15%. The government gives you a break on money taxed at 15% and then taxes that tax break at 25% later.

Depreciation Recapture (by 6x6 [TN]) Posted on: Sep 19, 2022 8:32 PM

Depreciation Recapture (by MMIT [VA]) Posted on: Sep 19, 2022 8:50 PM

Have you thought about a 1031 exchange for property that is less hassle (farmland, timber land, real estate syndication)?

How about a deferred sales trust?

How about offsetting the gains with a conservation syndication?

How about owner financing to a younger investor?

Good luck!

Depreciation Recapture (by plenty [MO]) Posted on: Sep 19, 2022 9:52 PM

6x6 is speechless!

Depreciation Recapture (by S i d [MO]) Posted on: Sep 19, 2022 10:09 PM

To understand recapture you first have to understand what depreciation is.

As I have said many times before on this forum, depreciation is a TAX concept. It has no basis in reality. But, it is a somewhat useful way to interpret reality and provide a solution to a problem casued by tax laws.

Here's the problem: when investor Sid buys a house, he spends $50,000. I rent it for $1000 a month. Since I spent that money to generate that income, theoretically I should be allowed to not pay any taxes on any of that rent income for 4 years and 2 months. In addition I'd also be deducting all of my other expenses such as maintenance, taxes, insurance, interest, and utilities, so my income would be waaaaay far down in the negative Zone for probably at least 10-12 years.

Now....does anyone here seriously think Uncle Sam is going to wait 10-12 years to get his pound of flesh? Hardly!

So what the IRS did is adopt the concept of depreciation, which says that even thought you spend $50000 on a house, the house is still worth something at the end of the year, so you didn't really "lose" that money the same was as if I was Sid's hamburger shop and had to use up the full value of the meat each time I sell a burger. So instead of letting me deduct the entire $50,000 cost of the house in year 1-6, the IRS says I can deduct only part of the value (1/27.5 specifically).

So theoretically, at the end of 27.5 years, my $50,000 is worth has fallen apart and is a wreck...not even worth scrap value. It is "fully depreciated" just like a worn out machine on an assembly line in a factory or a used up box of hamburger patties.

Ah, but now here is where the spreadsheet fails to match reality: the house is probably not only worth at least $50,000, but if I've kept it up it's probably worth at least double what I paid for it due to inflation.

So now I got to sell my "worthless" house that the IRS has told me worth $0 on my spreadsheet tax deduction ledger, but got $200,000 for it! That means you're house isn't worthless after all, Mr Sid...screams the IRS. You made a profit selling this valuable house! You must be taxed!

So the IRS reassigns (recaptures) the value to the assets that they told me was gone. They've decided 25% is a Fair rate for this, since otherwise we'd have to go back and refigure 27 years of my tax filings and what my effective tax rate actually wod have been at that time has I sold the house that year for an unknown amount and....uggghhhh! Let's just used 25% and call it good.

So, in summary: recapture is the IRS finally acknowledging the reality that we all know about how a maintained house keeps its value. Even though for 27.5 years you or your CPA was telling the IRS that your house was gradually being used up, it was actually doing just fine! So heck yeah, you're going to pay taxes on that.

Btw, the irony here is the IRS requires you to lie to them about the house losing value each year, and if you don't claim depreciation they will still tax you on recapture later even if you fail to claim a penny of write off. Funny how that works...

Make sense?


Depreciation Recapture (by Roy [AL]) Posted on: Sep 19, 2022 10:17 PM


I have 2 houses in D hoods. Even though they are cash cows and produce consistent 35% returns, the hassle factor of managing these houses and the tenants, is beginning to wear me down. I just want to cash out, take the money and run,...especially before the housing market crashes in the next 3-6 months.

Depreciation Recapture (by S i d [MO]) Posted on: Sep 19, 2022 10:21 PM

This also demonstrates why depreciation -- while not based in reality -- is one of the best parts of real estate as a wealth building strategy. You get a tax break for "using up the house" to generate rental income, but I reality you're spending on things like a new roof, new paint, new HVAC systems, etc to make sure the house stays as valuable as ever and hopefully goes up in value.

Best part? You get to double dip. You write off both maintenance expenses that preserve the value and useful lifespan of the house AND ALSO write off the depreciation expense! Sounds crazy, but that's how it works.


Depreciation Recapture (by Roy [AL]) Posted on: Sep 19, 2022 10:31 PM


Your example makes perfect sense to me even though depreciation has no basis in reality!

Depreciation Recapture (by don [PA]) Posted on: Sep 20, 2022 3:06 AM

Because the tax code lets you pretend that a house is "worn out" after 27.5 years and worth zero and you can deduct as if that was happening each year a little at a time. In reality, we know that with proper maintenance a structure can last centuries. The recapture tax is recapturing the depreciation deductions that did not really happen.

Depreciation Recapture (by Oregon Woodsmoke [ID]) Posted on: Sep 20, 2022 10:58 AM

The short and easy to understand answer is "because the government says so"

Don't try to apply logic to the tax system. You'll just frustrate yourself. The only real reason is because the government wants your money to spend in a wasteful manner.

Allowing depreciation on rentals is basically to encourage investors to invest in residential housing by waving around a tempting (but disguised fish hook) tax break. It helps to keep the population housed.

Depreciation Recapture (by S i d [MO]) Posted on: Sep 20, 2022 11:44 AM

I think Oregon is generally correct saying that depreciation is sort of a "gimmie" to encourage certain behaviors (isn't everything in the tax code?)

We do get to double dip since we get to deduct the expenses of maintenance, but then also deduct the expense of the initial asset as well even though it's usually going up or at least holding value. The trade off is we don't get to immediately deduct (expense) the house when we buy it. We get to do it slowly, the (potentially) repay it later.

What some do though to avoid this is bequeath the property to their heirs who then inherit it on a stepped up basis, meaning not only is depreciation recapture voided, but also any capital gains. It truly is a way to build generational wealth!

For someone without family heirs--such as my buddy Roy--another strategy some use is equity stripping. Maybe you have $3 million in paid off real estate in your portfolio, but rather than sell that and pay who knows how much in taxes and depreciation recapture, they'll just borrow up to 80% LTV ($2.4 million) and live off the proceeds, allowing the rents to service the debt. Loan proceeds are not considered profit or taxable income, so you incur zero tax liability.


Depreciation Recapture (by Heartland [NC]) Posted on: Sep 21, 2022 9:54 AM

At some backyard BBQ’s I get challenged for real estate depreciation. Here is how I explain it to the general public. I am not a lawyer or accountant. Take my explanation and verify it with your own lawyer and/or CPA.

All business costs are deductible from revenues because the costs enable the generation of the revenue.

The purpose of depreciation is to match the cost of a purchase against the revenue it enables.

A woodchipper costs $10,000. It has a life span of 5 years.

If depreciation is not allowed. I would deduct the $10,000 immediately in 2022. It might take some years for me to report a profit and the IRS misses the opportunity to collect taxes for a few years.

Thus, depreciation. We match the cost against the 5 years of revenues it enables. Or, $2,000 depreciation for each of 5 years. Then the woodchipper has $0 value at the end of 5 years. I have to purchase a replacement woodchipper because the old woodchipper is worn out.

Imagine if I could immediately (in 2022) deduct a $250,000 townhome purchase. It would be many years before I would show any taxable profit. Surely the neighbor at the BBQ wouldn’t favor that I could expense the $250,000 immediately. I get to expense something because the $250,000 purchase enables me to generate rental revenues.

So, I depreciate the building’s value over 27.5 years. $250,000 purchase less $25,000 land value for a $225,000 building value. $225,000 divided by 27.5 equals $8,182 per year in depreciation. The $8,182 is matched against 2022’s revenue and against each subsequent year.

My original cost basis (for capital gains tax) is $250,000. 10 years of depreciation expenses equals $81,820. Tax wise, I represented to the IRS that my $225,000 purchase in 2022 was expensed downward over the last 10 years by $81,820. When I sell the property for $500,000 in 2032, my cost basis changes.

$500,000 less the adjusted purchase price determines the taxable capital gain. The property cost me $250,000 but I expensed $81,820 over the last 10 years. The adjusted value is $250,000 less $81,820 for $168,180. My capital gain is $500,000 less the adjusted value of $168,180 for a capital gain of $331,820.

This explanation stops the neighbor in their tracks. They drop their “tax gimmick” attitude and have an improved understanding of capitalism.

Depreciation Recapture (by WMH [NC]) Posted on: Sep 21, 2022 1:31 PM

Thanks for that explanation, very good!!

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