If those fees cost you $300, you'd subtract that from the sale price. This value would be your net proceeds. You'd then subtract $12,000 from that value to earn a realized gain of $1,500. However, if there was a loss at the point of the depreciated asset's sale, you wouldn't be able to recapture a depreciation.
You might be able to minimize the tax hit from depreciation recapture. Potential strategies include purchasing replacement property in a Section 1031 exchange, timing the sale of business property to when you're in a lower tax bracket, and investing in a Qualified Opportunity Fund.
Sections 1245 and 1250 were enacted to close the loophole that resulted from allowing depreciation deductions on assets to offset ordinary income while taxing gain from the sale of these depreciated assets as capital gains.
Unrecaptured Section 1250 gains are usually taxed at a 25% maximum rate. Section 1250 gains can be offset by Section 1231 capital losses.
If the investor's property has been depreciated over many years, the additional depreciation — the part subject to “recapture” — may be relatively small. As a result, a significant portion of the gain due to depreciation may be treated as a long-term capital gain that can be offset with capital losses.
Since most depreciable real property is depreciated under the straight-line method, true section 1250 recapture generally does not apply. Some circumstances where it may apply is where accelerated and/or bonus depreciation property is taken on real property such as land improvements or qualified improvement property.
Depreciation recapture is treated as ordinary income and taxed as such. With real estate, the gain beyond the original cost basis is taxed as a capital gain, whereas the part related to depreciation is taxed at the unrecaptured gains section 1250 tax rate, capped at 25%.
Under section 121 of the Internal Revenue Code, you may be able to exclude much of the gain from the sale of your main home that you also used for business or to produce rental income, if you meet the ownership and use tests.
While a primary residence qualifies for a gain exclusion of $500,000 (or $250,000 if single), the depreciation recapture tax liability does not get wiped out.
Moving Back In to Save on Taxes
Moving back into your rental to claim the primary residence gain exclusion does not allow you to exclude your depreciation recapture, so you might still owe a hefty tax bill after moving back, depending on how much depreciation was deducted (IRS, 2023).
This increase in depreciation expense causes your current losses to exceed $100,000 and allows you to offset the entire capital gain from sale. Check out more topics on rental property tax deductions: Rental Property Accounting Basics.
Investors can defer depreciation recapture by engaging in a 1031 property exchange, also called a like kind exchange. The specific rules of a 1031 Exchange are outlined in section 1031 of the internal revenue code, but they can be complex.
Depreciation is a valuable deduction for rental property owners since it helps offset natural wear and tear or damages that happen over time. However, if you plan on selling the property, depreciation that's been taken out must be recaptured and paid back to the government.
Although profit on selling a rental property might have to be reported as capital gains, losses when selling rental property are deductible from your ordinary income.
“If a good part of your portfolio is up in value, while a smaller part is down,” Curtin says, “selling some of those 'down' investments at a loss — known as tax-loss harvesting — could help offset the tax you owe from the gains earned on your sale of better-performing stocks.”
Remember that any depreciation recapture can not be excluded from taxable income under Section 121 and would be recognized and included in the year the property is actually sold.
Sale of your principal residence. We conform to the IRS rules and allow you to exclude, up to a certain amount, the gain you make on the sale of your home. You may take an exclusion if you owned and used the home for at least 2 out of 5 years. In addition, you may only have one home at a time.
For example, if you lived in the property for 50% of the time and rented it out for the other 50% of the time, you may be able to exclude up to 50% of the capital gain. Rental Property: If you sell a rental property, you don't qualify for the Section 121 exclusion.
To calculate a property's depreciation recapture value, subtract the adjusted cost basis from the original cost basis. The resulting figure is the amount the IRS will tax you to recapture depreciation. If the sale of the property results in a net loss, the IRS will not recapture the depreciation.
This means that these four types of 19-year (or 18- or 15-year) ACRS real property and low-income housing that have specifically defined as subject to recapture under Section 1250, and that all other ACRS real property is subject to recapture under Section 1245.
Additional depreciation is recaptured at the applicable income rate, without a 25% cap. In a 1031 exchange, depreciation is recaptured to the extent the value of depreciable property acquired as replacement property is of a lesser value.
Once you've determined the type of asset you hold, calculate its adjusted cost basis. This calculation is the price you originally paid for the asset minus any accumulated depreciation expenses. Subtract the adjusted cost basis from the asset's sale price to calculate depreciation recapture.
Can Rental Depreciation Offset Ordinary Income? Yes, but it's best to consult a tax professional to make sure it's in your best interest to do so.