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.
The second method investors can use to defer depreciation recapture is to complete a 1031 or like-kind exchange. If you swap one investment property for another and roll the entirety of sales proceeds into the new asset, you can defer both depreciation recapture and capital gains taxes.
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.
There is no law that states that you have to depreciate your rental property. This is a tax advantage to lower the income tax you pay on the rental income. If you do not take the standard depreciation, then you just pay more income tax each year.
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).
File an amended return: This only works if you didn't deduct depreciation on your rental assets for one year. Go back and amend the return to reflect the missed depreciation. Note: You can only go back one year to claim a possible refund for missed depreciation.
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%.
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.
Depreciation recapture is triggered by a gain on the sale of an asset where the adjusted basis of the asset is used to compute such gain. The adjusted basis of the asset is the original cost basis of such asset reduced by depreciation deductions previously allowed or allowable.
Depreciation stops either when the client has fully recovered their cost or other basis, or when the property is no longer being used to generate income — whichever happens first.
If you depreciated nonresidential real property which was placed in service before 1987 and you depreciated the property placed in service using just straight-line depreciation, there would be no Section 1250 depreciation recapture.
The downside of depreciation is depreciation recapture, which rears its claws upon sale of a depreciated asset. Depreciation recapture is the portion of your gain attributable to the depreciation you took on your property during prior years of ownership, also known as accumulated depreciation.
The 121 exclusion allows homeowners to exclude capital gains but not depreciation recapture from their taxable income when they sell their primary residence that was also held as an investment property.
The short answer is that depreciation on a rental property doesn't need to be paid back in a literal sense. Because depreciation is considered a non-cash expense, it doesn't involve any actual expenses out-of-pocket.
Under § 1031(f)(1), a taxpayer exchanging like-kind property with a related person cannot use the nonrecognition provisions of § 1031 if, within 2 years of the date of the last transfer, either the related person disposes of the relinquished property or the taxpayer disposes of the replacement property.
To avoid recapture of depreciation deductions on the home office, taxpayers do not claim depreciation. The depreciation allowed is the amount you claimed on your tax return. The depreciation allowable is the amount you should have claimed on your tax return.
Because personal property depreciates on a faster scale than real property, avoidance of depreciation recapture is often the reason for structuring a Personal Property Exchange, and many do not realize that taxable gains on these properties can be deferred.
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.
Is Depreciation Allowed on Inherited Property? You must use the inherited property for an income-producing activity or business. This includes using it as a rental property. If the inherited property is used for business and personal use, you can only use the percentage of business use to calculate depreciation.
Form 3115 will have to be filed, with the entire amount of incorrect or overlooked depreciation deducted in full in the year of correction via Form 3115. The total depreciation adjustment is called a Section 481(a) adjustment, which, if negative may be deducted in full in the year of change.
If you own a rental property, the federal government allows you to claim the depreciation of the property every year for 27.5 years. If you use the property for business or farming for more than 1 year, you can deduct the depreciation on your tax return over a longer period.