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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 4197
Experience:  Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
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elaborate on depreciation recapture on a rental property that

Resolved Question:

elaborate on depreciation recapture on a rental property that has been converted to a second home and sold. Also are the accumulated book losses while a rental property able to be deducted from the gain to reduce taxes in this situation.
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

Lane :

Hi,

Lane :

Please don't shoot the messenger here, but it really works the other way around;

Lane :

Since you get to write off an expense without actually spending money, depreciation should be a benefit to you for as long as you own the property and it still has value to depreciate. You don't need to worry about paying it back until you sell the property. That's when you actually experience a taxable event and can incur a gain.

Lane :

Because depreciation is an accounting tool that lets you adjust value for "using up" the value of your asset, the IRS expects that you will sell it for less than the depreciated value. If you sell your asset for more that its depreciated value, the IRS requires you to pay it tax on that gain. This tax is called "Depreciation Recapture Tax" and is also referred to as Section 1250 recapture.

Lane :

The tax rate on recaptured deprecation is 25 percent. (This comes under Title 26 of the US code - the internal revenue code) section 1250 ... IRC § 1250

Lane :

Here's an example from an excellent article on this: from http://homeguides.sfgate.com/paying-back-depreciation-rental-property-42080.html

Lane :

Consider a rental property that you bought 15 years ago for $250,000 and just sold for $350,000. Your analysis showed that $180,000 of the value was in the depreciable buillding and $70,000 was in non-depreciable land. You would have a $100,000 capital gain on the difference between the original purchase price and the selling price, taxable at 15 percent in the 2012 tax year. In addition, the $6,545 per year depreciation that you claimed based on the asset's 27.5 year life, which adds up to $98,175, is taxable at 25 percent as recapture. This leads to a total tax bill on the sale of $39,544, based on $15,000 in gains tax and $24,544 in recapture tax.

Lane :

And here's the IRS guidance on this:

Lane :

I still don't see you coming into the chat session, so I'll move us to the "Q&A" mode. … Maybe that will help … (We can still continue a dialogue there, just not in real-time chat, as we can here)

Lane :

Please let me know if you have any questions at all ...

Lane :

Let me know …


Lane

Expert:  Lane replied 1 year ago.
Our chat has ended, but you can still continue to ask me questions here until you are satisfied with your answer. Come back to this page to view our conversation and any other new information.

What happens now?

If you haven’t already done so, please rate your answer above. Or, you can reply to me using the box below.
Expert:  Lane replied 1 year ago.

Hi Bruce,

… just checking back in here, as I never saw you come into the chat.


Please let me know if you need anything else at all on this.


Lane


Customer: replied 1 year ago.

Did you get my last message regarding accumulated book loses?

Expert:  Lane replied 1 year ago.

Sorry, did not see that part.

Yes, it IS at sale that those passive losses can be used to OFFSET that gain.

The accumulated losses you have not been able to deduct are allowed in full in the year you sell or dispose of your entire interest in the property. You would apply the accumulated passive losses against your gain on the sale or disposition of the property.

DO note that the sale cannot be to a related person.
Customer: replied 1 year ago.

What about change from rental to second home and can losses be deducted from 1250 gain

Expert:  Lane replied 1 year ago.

Yes:

Conversion to personal use is not fully taxable event. The conversion of MACRS property, your rental property, from your rental business or income-producing use to personal use during a taxable year is treated as a disposition of the property in that taxable year.

However, upon the conversion to personal use, no gain, loss, or depreciation recapture under section 1245 or section 1250 is recognized.

However, the provisions of section 1245 or section 1250 apply to any disposition of the converted property by the taxpayer at a later date. So, those losses remain suspended until you have a taxable disposal .

Lane
Customer: replied 1 year ago.

Does that mean that there is no penalty for converting to personal use upon sale. i.e. the taxes I would incur on sale would be the same whether I converted it to second home or left it as a rental property until sale?

Expert:  Lane replied 1 year ago.

That's correct,... the losses stay suspended until you have a taxable event ... and since this isn't your primary residence, you have a taxable event here.

Sp both the depreciation recapture AND the accumulated losses come to play

Lane
Customer: replied 1 year ago.

Can the accumulated losses be deducted from the 1250 gain first to avoid the higher tax rate?

Expert:  Lane replied 1 year ago.

No,

 

 

 

The portion of Accumulated Depreciation which corresponds to straight line depreciation is called "Unrecaptured Section 1250 Gain"

 

 

That's the 25% piece. (the logic/policy here is that you took the depreciation at ordinary income tax rates... the 25% is essentially a surrogate for ordinary income rates)

 

 

The remainder of any gain realized is considered long-term capital gain, provided the property was held over a year, and is taxed at a capital gains rates.

Customer: replied 1 year ago.

Can i copy the responses you've sent?

Expert:  Lane replied 1 year ago.

SURE

Here's the link to come back whenever you like: http://www.justanswer.com/tax/82bgt-elaborate-depreciation-recapture-rental-property.html

OR you can bookmark in your browser

OR, you can file-print from your browser.

And finally, you should be able to always get back here from your home page



Hope this has helped,

Lane

If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better … That's the only way they will pay us here.

HOWEVER, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question.

Customer: replied 1 year ago.

Lane, thanks for your help. One last question. Do I need to notify the IRS when I convert or do I just submit the tax return treating the it as a second home (i.e., only deducting real estate taxes) . Bruce

Expert:  Lane replied 1 year ago.

Nope, you'll just report the sale, as you would the sale on any other asset.

It's the sale that triggers your being able to use the losses and requires that you include the depreciation.

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 4197
Experience: Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
Lane and 2 other Tax Specialists are ready to help you

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