Depreciation Recapture on property - What
is depreciation recapture?  When must you
recapture depreciation on your property?  Read
below to learn about Depreciation Recapture!

What is Depreciation Recapture?
When property is sold at a gain, some element of that gain is
attributable to depreciation deductions taken in prior years.  Under
current law, commercial property has a depreciable life of 39 years.
This means that the owner of the residential or commercial rental
property must deduct 1/39th of the original cost of the building
purchased after 1993.  As a result of this depreciation, the adjusted tax
basis of the rental property also decreases. Because the gain is the
difference between the selling price and this adjusted basis, the
depreciation element of the gain is taken into account and taxed as
capital gain. This is called depreciation recapture; paying taxes
on the gains that are attributed to depreciation.  For all property
sold on or before May 7, 1997, all capital gain was taxed at 28 %.
Real estate sold after May 7, 1997 is recaptured at a 25% rate.



When Must You Recapture the Depreciation
When you dispose of property that you depreciated using MACRS,
any gain on the disposition generally is recaptured (included as
income) as ordinary income up to the amount of the depreciation
previously allowed or allowable.  This includes any Section 179
deduction claimed on the property and any special depreciation
allowance for Liberty Zone property. 

To figure any gain that must be reported as ordinary income, you must
keep permanent records of the fact necessary to figure the depreciation
or amortization allowed or allowable on your property.  This includes
the date and manner of acquisition, cost or other basis, depreciation or
amortization, and all other adjustments that affect basis. 

Depreciation Recapture for Residential Property
There is no recapture for residential rental property and non residential
real property unless that property is qualified property for which you
claimed a special depreciation allowance. 

If you rent part of your home, have a home office, or rent a house or
other form of property and have taken out depreciation after May 6, 1997,
any gain on the sale of your property up to the amount of depreciation
you have taken will be taxable at your normal rate up to a maximum
long-term capital rate of 25% as long as you have owned the property
for at least one year; otherwise it's taxed at your income tax rate.

Example:  Shane sold his house in 2007 for a $125,000 gain.  He used
his home as a home office and claimed depreciation in the amount of
$10,000 on part of his home.  Once he sells the house, Shane must pay
tax on the $10,000 at the rate of 25%.  If he held the property for less than
12 months, the tax rate on the depreciation would be at his ordinary
income tax levels.

Note that if you are in a income tax bracket which is higher than the
25% rate, 36% for example, you are still coming out ahead by
taking the depreciation deduction. 


Depreciation Recapture for Like-Kind Exchanges
If you have a gain from either a like-kind exchange or an involuntary
conversion of your depreciable real property, you do not have to report
the income if it is carried over to the depreciable real property acquired
in the like-kind exchange. 

Example:  Jeff Sigalla purchases a home for $100,000 and has
accumulated $60,000 in depreciation.  Jeff's tax basis is $40,000 ($100,000 -
$60,000).  Assuming Jeff sells his home and does a 1031 like-kind exchange
for another property  that has a fair market value of $200,000.  The adjusted
basis would transfer to the new property and represent the first $100,000 of
the new property.  Hence, the basis for the new property would be
$140,000 ($40,000 basis in the original property in addition to the $100,000
additional amount paid to purchase the new property with the $200,000
purchase price).

To learn more about the 1031 exchange, visit our detailed overview of the
1031 exchange of like kind property.


Understand Depreciation Recapture
You may say to yourself, "Well, I don't have to worry about depreciation
recapture if I don't elect to use it".  You would be very wrong.  The IRS
included depreciation recapture in the tax law so you are liable whether you
used it or not.  You must recapture depreciation you actually claimed or could
have claimed for renting out the house.



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