Author Topic: rental property depreciation recapture in retirement?  (Read 13748 times)

zephyr911

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Re: rental property depreciation recapture in retirement?
« Reply #50 on: February 12, 2016, 07:49:25 AM »
In case there's any doubt on this point, Crane v. Commissioner, 331 US 1 (1947) is authority for the proposition that the ratio of land value to building value can be different at sale compared to acquisition. It is not the main point of the case, but in passing the Supreme Court says the following:

                  The original basis [of the property] was $262,042.50, its appraised value in 1932. Of this value $55,000.00 was allocable to land and $207,042.50 to building. During the period that petitioner held the property, there was an allowable depreciation of $28,045.10 on the building, so that the adjusted basis of the building at the time of sale was $178,997.40. ... The [1938] selling price [of $257,500.00] was allocable in the proportion, $54,471.15 to the land and $203,028.85 to the building.
331 US at 4 (footnote markers omitted).

In this particular example, the acquisition and sale ratios differ from each other by less than 1%, but they are not the same.

I would expect the ratio to be different in virtually every case, because both valuations are driven by different factors, not the least of which is depreciation only affecting the improvments.

Yes, your overall gain on the sale is $100k.  But the portion of that gain that is attributable to depreciation adjustments will be taxed at your ordinary income rate (capped at 25%), while the balance of the gain will be taxed at the capital gains rate.  And the portion of the gain that is attributable to the depreciation adjustments will depend on the portion of the gain that is attributable to the building as opposed to the land.  So the land/building breakdown at the time of the sale does matter for purposes of determining your tax liability as a result of the sale.  That was NoNonsense's point, which I had never seen raised before.

You're saying you calculate two separate gains, one for land and one for structure? This is a detail I hadn't previously grasped.
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brooklynguy

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Re: rental property depreciation recapture in retirement?
« Reply #51 on: February 12, 2016, 08:19:20 AM »
You're saying you calculate two separate gains, one for land and one for structure? This is a detail I hadn't previously grasped.

Yes, because only the portion of the total gains allocable to the building (and not the portion allocable to the land) can constitute gains attributable to depreciation adjustments (i.e., what was originally referred to in this discussion as "recapturable gains" but, as Cathy points out, what the tax code calls "unrecaptured section 1250 gains"), and only that portion is subject to ordinary tax rates (capped at 25%), while the balance of the gains (i.e., the portion of the gains allocable to the building that is not attributable to reduced basis caused by depreciation adjustments, and all of the gains allocable to the land) is subject to capital gains rates.

This is a detail I hadn't grasped either before NoNensense pointed it out.  There usually seems to be an underlying default assumption in these discussions that the adjusted basis will always be "recaptured" (unless the actual sale price is lower than the actual purchase price by at least the full amount of the reduction in basis caused by depreciation adjustments), implicitly reflecting an assumption that the ratio of land value to building value does not change between acquisition and sale (or, alternatively, that it only changes in one direction, skewing more value towards the building side of the ratio).

However, as you point out, in reality, one would expect the ratio to virtually always change to some extent between acquisition and sale (unless the sale happens very quickly after the acquisition).  And, as I pointed out, under ordinary circumstances, one would expect the ratio to change in the direction generally favorable to the taxpayer (skewing more value towards the land side), because buildings generally depreciate in value (in reality, not just for tax purposes) while land generally does not.  Which, again, is why I wonder (i) why this intriguing point does not get raised more often (NoNonsense's post was the first time I had seen it mentioned, and it sounds like you were not previously aware of it either), and (ii) how prevalent it actually is in practice for taxpayers to avoid (at least some) "recapture" by using a different land-to-building ratio at the time of sale.

Edited to fix italics tags and make minor wording changes.
« Last Edit: February 12, 2016, 08:27:08 AM by brooklynguy »

zephyr911

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Re: rental property depreciation recapture in retirement?
« Reply #52 on: February 12, 2016, 08:26:30 AM »
Which, again, is why I wonder (i) why this intriguing point does not get raised more often (NoNonsense's post was the first time I had seen it mentioned, and it sounds like you were not previously aware of it either), and (ii) how prevalent it actually is in practice for taxpayers to avoid (at least some) "recapture" by using a different land-to-building ratio at the time of sale.

The tax code is like a damn onion, and you can even consult some IRS pubs and not get the full, detailed version of the above. This goes to the heart of why I am currently setting the stage for handing off my business accounting to a CPA in the next 12-18 months. Even after volunteering for years as a tax preparer, doing it professionally for one season, owning rentals for almost a decade, and doing my best to self-educate and self-perform all along the way, I'm still peeling back layers and getting tired of the tears*! ;)

*send the waambulance, I'll be waiting
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monarda

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Re: rental property depreciation recapture in retirement?
« Reply #53 on: February 12, 2016, 09:13:03 AM »
Following, as we're both thinking of selling a rental and retiring in the next couple of years.

arebelspy

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Re: rental property depreciation recapture in retirement?
« Reply #54 on: February 12, 2016, 09:49:47 AM »
Which, again, is why I wonder (i) why this intriguing point does not get raised more often (NoNonsense's post was the first time I had seen it mentioned, and it sounds like you were not previously aware of it either), and (ii) how prevalent it actually is in practice for taxpayers to avoid (at least some) "recapture" by using a different land-to-building ratio at the time of sale.

The tax code is like a damn onion, and you can even consult some IRS pubs and not get the full, detailed version of the above. This goes to the heart of why I am currently setting the stage for handing off my business accounting to a CPA in the next 12-18 months. Even after volunteering for years as a tax preparer, doing it professionally for one season, owning rentals for almost a decade, and doing my best to self-educate and self-perform all along the way, I'm still peeling back layers and getting tired of the tears*! ;)

*send the waambulance, I'll be waiting

Don't kid yourself; the CPAs usually don't even know this stuff, sadly.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
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brooklynguy

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Re: rental property depreciation recapture in retirement?
« Reply #55 on: February 12, 2016, 10:09:33 AM »
Don't kid yourself; the CPAs usually don't even know this stuff, sadly.

Yep.  It comes up from time to time in the forum (such as here), but I'll reiterate my view from the linked thread (which applies not just to certified financial planners, but also to CPAs, lawyers, and outsourceable advisors of all stripes):

Someone looking to obtain (and willing to pay for) good advice with minimal effort should seek the advice of a qualified financial advisor (but still put in the effort of conducting appropriate due diligence in the selection of that qualified financial advisor).

But the DIY route is a perfectly valid alternative for someone with the ability and willingness to self-learn (and I would even argue that, generally speaking, that is the better alternative for aspiring early retirees, who tend to have specialized needs and circumstances that mainstream financial advisors don't have familiarity or experience with).

. . .

Although most of the armchair analysts in this forum are amateurs, I wouldn't discount the value of the advice that is available here (for free no less!) even as compared to the advice of bona fide experts.  Everyone should of course do their own diligence and back-up research, but, on these issues, I would personally value the advice of just about any of the posters who responded in this thread above that of, say, the average certified financial planner.

This stuff is complicated, and the consequences of getting it wrong can be not-insignificant, so anyone who chooses to handle it themselves should make sure to put in the time, energy and research required to get it right.  But it's not open heart surgery, so I have no qualms about recommending that sufficiently motivated people take it upon themselves to insource.  The display of self-taught prowess on these topics on display in this thread alone is good support for that :)

And my comment about valuing the input of posters from that thread applies to the posters in this thread as well.

zephyr911

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Re: rental property depreciation recapture in retirement?
« Reply #56 on: February 12, 2016, 11:56:50 AM »
Don't kid yourself; the CPAs usually don't even know this stuff, sadly.
Well then, I may need to interview many of them and find a specialist (one more reason to start well in advance). I don't doubt my ability to learn the subject matter well enough to kick ass; I just doubt my desire to obtain and maintain that knowledge post-FIRE.


Don't kid yourself; the CPAs usually don't even know this stuff, sadly.

Yep.  It comes up from time to time in the forum (such as here), but I'll reiterate my view from the linked thread (which applies not just to certified financial planners, but also to CPAs, lawyers, and outsourceable advisors of all stripes):

Although most of the armchair analysts in this forum are amateurs, I wouldn't discount the value of the advice that is available here (for free no less!) even as compared to the advice of bona fide experts.  Everyone should of course do their own diligence and back-up research, but, on these issues, I would personally value the advice of just about any of the posters who responded in this thread above that of, say, the average certified financial planner.

This stuff is complicated, and the consequences of getting it wrong can be not-insignificant, so anyone who chooses to handle it themselves should make sure to put in the time, energy and research required to get it right.  But it's not open heart surgery, so I have no qualms about recommending that sufficiently motivated people take it upon themselves to insource.  The display of self-taught prowess on these topics on display in this thread alone is good support for that :)

And my comment about valuing the input of posters from that thread applies to the posters in this thread as well.
I second ALL of the above.

Also, I read that rather quickly the first time and I pictured someone insourcing open-heart surgery.
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Bearded Man

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Re: rental property depreciation recapture in retirement?
« Reply #57 on: February 20, 2016, 09:12:44 PM »
Which, again, is why I wonder (i) why this intriguing point does not get raised more often (NoNonsense's post was the first time I had seen it mentioned, and it sounds like you were not previously aware of it either), and (ii) how prevalent it actually is in practice for taxpayers to avoid (at least some) "recapture" by using a different land-to-building ratio at the time of sale.

The tax code is like a damn onion, and you can even consult some IRS pubs and not get the full, detailed version of the above. This goes to the heart of why I am currently setting the stage for handing off my business accounting to a CPA in the next 12-18 months. Even after volunteering for years as a tax preparer, doing it professionally for one season, owning rentals for almost a decade, and doing my best to self-educate and self-perform all along the way, I'm still peeling back layers and getting tired of the tears*! ;)

*send the waambulance, I'll be waiting

Don't kid yourself; the CPAs usually don't even know this stuff, sadly.

That's been my experience. I fired my CPA after I 1) realized I knew more about this stuff than he did even with a bachelors and masters degree in accounting from a state school and 2) he changed my return after I signed it one year. I now do it myself in less time, for more properties, and with a higher income, and I get way more money back now than I did with him. Software makes tax prep easier, although, honestly for rentals schedule E can be filled out by hand in a few minutes...

jimmylomax

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Re: rental property depreciation recapture in retirement?
« Reply #58 on: January 11, 2017, 04:13:29 PM »
... I actually don't see where it is specified that depreciation is recaptured at a fixed 25% regardless of ordinary income tax bracket, but I've read it enough times on this forum that I assume it is true.

That assumption would be a mistake, since it's not true.

Section 1250 of the Internal Revenue Code generally provides that, on the disposition of certain realty (including most residential rental real estate), gains attributable to depreciation adjustments that were "allowed or allowable to the taxpayer or to any other person" are not treated as capital gains but instead "shall be treated as gain which is ordinary income". 26 USC § 1250(a)(1)(A). The effect of these provisions is that gains attributable to certain depreciation adjustments would generally be taxed at the taxpayer's ordinary marginal rate. However, another provision of the Code specifies that certain gains attributable to depreciation adjustments are taxed at a maximum of 25%. 26 USC § 1(h)(1)(E)(i). The 25% maximum is a gift, not a punishment. It can only lower the amount that the taxpayer would otherwise owe.

Although the above analysis is sufficient, I will also explain where the same information is found in the IRS forms. If a taxpayer has any gains attributable to depreciation adjustments for certain residential rental real estate, those gains are reported on Line 19 of Schedule D to Form 1040. If a taxpayer reports an amount on that line, the instructions indicate that the taxpayer should figure her overall tax using the "Schedule D Tax Worksheet" found at page 15 of the Schedule D Instructions. That worksheet uses a rather complicated calculation to figure the tax, but for our purposes, we can jump to the last line (Line 45) where we see that the calculation chooses whichever is smaller: the normally-calculated tax, or the specially-calculated tax using this complicated worksheet. In other words, the special 25% rate applicable to certain gains can only lower the tax otherwise payable.

Sorry from dragging this back out, but I was just revisiting this (this year is my last year to sell and still qualify for the 2/5ths capital gains rule)...

I just reviewed the Schedule D worksheet and on Line 38 I see to multiply the value by a fixed 25% for the "normally-calculated tax". I'm have a bit of a hard time following the flow to that point, but I don't see anywhere that I'm paying a smaller percentage on some portion of the deprecation to be recaptured (since I'm in the 15% bracket). It appears to me pay the minimum of the fixed 25% OR the result of the complicated formula. I get that you can't pay more than 25% and I think I get that you might enjoy the other formula if it benefits you, but I don't see how you could pay a number less than 25 even if your ordinary income marginal bracket is 15 (or less).

Cathy

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Re: rental property depreciation recapture in retirement?
« Reply #59 on: January 15, 2017, 05:02:10 PM »
I just reviewed the Schedule D worksheet and on Line 38 I see to multiply the value by a fixed 25% for the "normally-calculated tax". I'm have a bit of a hard time following the flow to that point, but I don't see anywhere that I'm paying a smaller percentage on some portion of the deprecation to be recaptured (since I'm in the 15% bracket). ... I don't see how you could pay a number less than 25 even if your ordinary income marginal bracket is 15 (or less).
(Emphasis mine.)

First, as I noted in my post dated February 10, 2016, the sale of depreciable residential buildings generally does not trigger any depreciation recapture (but also see brooklynguy's rejoinder to that particular bit of pedantry).


As for the substantive question, I assume you are referring to the "Schedule D Tax Worksheet" on page 16 of the 2016 Instructions for Schedule D. The part of that worksheet that chooses the minimum of the normally-calculated tax and the alternative capital gain maximum rates is line 45, which chooses between the smaller of
  • line 43 (which includes 25% of unrecaptured section 1250 gains (line 19 of 2016 Schedule D)), and
  • line 44 (which uses the normal tax rates, which may be less than 25%).
As can be seen, this calculation (and in particular branch (ii)) could indeed result in paying less than 25% tax on the unrecaptured section 1250 gains (commonly, but incorrectly, referred to as the depreciation recapture).


I also should note that in the event of a conflict between the statutory scheme enacted by Congress and an IRS worksheet, the statutes would control. This is because, under the Constitution of the United States, "[a]ll [federal] legislative Powers ... shall be vested in a Congress of the United States", Art I, § 1, and not in the IRS. An attempt by the IRS to vary the laws enacted by Congress would be "a mere nullity". Manhattan General Equipment v. Commissioner, 297 US 129, 134 (1936). I am not suggesting that any such inconsistency has been identified here, only that if there had been one, it would not override the Internal Revenue Code.
« Last Edit: January 15, 2017, 05:18:18 PM by Cathy »
This post contains only general information on the issues raised by this topic. This post does not provide help tailored to your specific situation. There are many facts that could be relevant to your specific situation and I am not in possession of those facts. If you need help tailored to your specific situation, you should retain an appropriate professional and not rely on this post.

Mr Mark

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Re: rental property depreciation recapture in retirement?
« Reply #60 on: January 19, 2017, 03:15:16 AM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.

EDIT*** The above is incorrect, as pointed out by AREBELSPY later. If only it were that simple... I'll do a fresh post with an example later in the thread

« Last Edit: January 21, 2017, 11:46:57 PM by Mr Mark »
Mr. Mark

fishnfool

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Re: rental property depreciation recapture in retirement?
« Reply #61 on: January 19, 2017, 10:22:25 AM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.
Thanks for explaining that. We are leaning towards doing just that, live in it a few years then possibly sell the rental and buy something else. The only other scenario that makes sense is to keep renting it and taking the depreciation and let it pass on to our heirs.

Ciao

CareCPA

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Re: rental property depreciation recapture in retirement?
« Reply #62 on: January 19, 2017, 12:07:54 PM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.
Thanks for explaining that. We are leaning towards doing just that, live in it a few years then possibly sell the rental and buy something else. The only other scenario that makes sense is to keep renting it and taking the depreciation and let it pass on to our heirs.

Ciao
You should read this: https://www.irs.gov/publications/p523/ar02.html.
Pay special attention to the sections about "non-residence gain" (Allocating part of your total capital gain to the time it was a non-primary home), and the section about 1250 recapture.
The fool-proof ways of getting out of recapture are death and donation. 1231 exchanges prolong, and moving back in just alters the ratios.

Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.

arebelspy

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Re: rental property depreciation recapture in retirement?
« Reply #63 on: January 19, 2017, 12:31:51 PM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.

No no no no no...

This was changed like 7 years ago.

Do not spread this information, it's wrong.

The gains are prorated based on the amount of time it was a rental versus primary residence.  You don't get the 250/500 exemption anymore, and haven't for a long time.
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CareCPA

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Re: rental property depreciation recapture in retirement?
« Reply #64 on: January 19, 2017, 12:37:03 PM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.

No no no no no...

This was changed like 7 years ago.

Do not spread this information, it's wrong.

The gains are prorated based on the amount of time it was a rental versus primary residence.  You don't get the 250/500 exemption anymore, and haven't for a long time.
Sorry ARS, minor clarification to your point. You do still get the 250/500 exemption, but only on the gains that are allocated to the time period you used it as a primary residence. You are correct that this exemption does not apply to depreciation recapture or gains allocated to the time it was held as a rental.
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.

arebelspy

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Re: rental property depreciation recapture in retirement?
« Reply #65 on: January 19, 2017, 01:41:21 PM »
Sorry ARS, minor clarification to your point. You do still get the 250/500 exemption, but only on the gains that are allocated to the time period you used it as a primary residence. You are correct that this exemption does not apply to depreciation recapture or gains allocated to the time it was held as a rental.

Good clarification, thanks!  :)

Just to the idea of "Moving back in for two years" to exclude 250/500, it no longer works that way (unless it gains 250/500 in those two years, I suppose... but none of the earlier gains as a rental are counted in that).
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (occasionally) blog at AdventuringAlong.com.
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jimmylomax

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Re: rental property depreciation recapture in retirement?
« Reply #66 on: January 19, 2017, 10:53:15 PM »
I just reviewed the Schedule D worksheet and on Line 38 I see to multiply the value by a fixed 25% for the "normally-calculated tax". I'm have a bit of a hard time following the flow to that point, but I don't see anywhere that I'm paying a smaller percentage on some portion of the deprecation to be recaptured (since I'm in the 15% bracket). ... I don't see how you could pay a number less than 25 even if your ordinary income marginal bracket is 15 (or less).
(Emphasis mine.)

First, as I noted in my post dated February 10, 2016, the sale of depreciable residential buildings generally does not trigger any depreciation recapture (but also see brooklynguy's rejoinder to that particular bit of pedantry).


As for the substantive question, I assume you are referring to the "Schedule D Tax Worksheet" on page 16 of the 2016 Instructions for Schedule D. The part of that worksheet that chooses the minimum of the normally-calculated tax and the alternative capital gain maximum rates is line 45, which chooses between the smaller of
  • line 43 (which includes 25% of unrecaptured section 1250 gains (line 19 of 2016 Schedule D)), and
  • line 44 (which uses the normal tax rates, which may be less than 25%).
As can be seen, this calculation (and in particular branch (ii)) could indeed result in paying less than 25% tax on the unrecaptured section 1250 gains (commonly, but incorrectly, referred to as the depreciation recapture).


Ok, thanks Cathy! Yes, correct, Schedule D worksheet. So, again, please forgive my ignorance. Trying to read through this stuff makes my head spin. If you want to talk cam lobes and crankshafts, I’m your guy.

So I had it in my head that branch (i) was supposed to be the path that allowed one to pay less than 25%. I think the reason I got tripped up is because when I filled in the magic Excel workbook the branch (ii) complicated formula resulted in a much larger number, but I believe this was due to including Capital Gains which I input on Schedule D (II) Line 11 (which carries into the Sch D Worksheet line 7) and then seems to drastically increase worksheet line 43 more than line 42.  So, I took out any gains (SchD line 11) and input $100k for Unrecaptured Section 1250 Gain (SchD L19). I assume this $100k number would represent the actual total of depreciation expenses I included on my Schedule E all the years before sale (I tried reading the Unrecaptured Section 1250 Gain Worksheet on page 14 of the link you just shared, but couldn’t make it past the first line).

Assuming my worksheet is accurate (which may be a poor assumption), it seems that since any capital gains are applied to taxable income, it takes us only a couple grand in cap gains to push us into the 25% bracket. So, after playing with some quick numbers, it seems if there are any capital gains from the sale at all, you’re pretty much going to pay 25%, but if you break even on the sale price or even take a loss, you may actually pay some number less than 25%. For some reason if I input Capital Gain from sale of $0, lines 42 and 43 are not factoring in Unrecaptured Section 1250 Gain. I’m happy to share the workbook if that helps, but I think I’m getting off in the weeds. I think it is most likely correct and I am grossly misunderstanding the difference between “the taxation of unrecaptured gains attributable to depreciation adjustments, as opposed to the recapture of depreciation adjustments. ”

Maybe we should let my incompetence alone and take a step back…

Said another way, for my case, which I assume would be most FI-seeking folks with almost any capital gains at final sale after holding the property for more than a few years, it sounds like what sol said is approximately appropriate as a general rule (although both his and my terminology is clearly not correct): While I have and plan to indefinitely take all my annual depreciation expenses against a 15% marginal tax bracket, I should anticipate “paying it back” at very close to or exactly 25%... so while I got an awesome injection of cash flow all these years it wasn’t an interest free loan, it will carry a 66% additional tax (25%/15%-1) so-to-speak. Granted most of this money was invested over many years and likely far outperformed my “additional tax”.

Please, I would be so happy for someone to help me understand how I am probably wrong and this might not be the most likely outcome for someone in a similar situation (in layman’s terms hopefully).



I also should note that in the event of a conflict between the statutory scheme enacted by Congress and an IRS worksheet, the statutes would control. This is because, under the Constitution of the United States, "[a]ll [federal] legislative Powers ... shall be vested in a Congress of the United States", Art I, § 1, and not in the IRS. An attempt by the IRS to vary the laws enacted by Congress would be "a mere nullity". Manhattan General Equipment v. Commissioner, 297 US 129, 134 (1936). I am not suggesting that any such inconsistency has been identified here, only that if there had been one, it would not override the Internal Revenue Code.
I have absolutely no idea how to use thisinformation ;)

fishnfool

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Re: rental property depreciation recapture in retirement?
« Reply #67 on: January 20, 2017, 04:58:46 AM »
So to save me from reading all the irs tax code, does that depreciation follow on to the next property if you do a 1031 exchange?

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Re: rental property depreciation recapture in retirement?
« Reply #68 on: January 20, 2017, 05:23:18 AM »
So to save me from reading all the irs tax code, does that depreciation follow on to the next property if you do a 1031 exchange?

It sure does (which is a good thing) . The only way out of "playing it back" , as I understand it, is to keep some sort of like kind property until your death at which time the depreciation is essentially struck from the record when the property passes to your estate. Congratulations kids, dad (or mom)  was a baller!

The like kind property can be a REIT, which is basically stock in rental property and is structured to maximize dividends.

One wrinkle I just learned is if you still carry debt against the property you sell, you will have to cover that amount as well in cash toward the REIT purchase.   
« Last Edit: January 20, 2017, 05:46:53 AM by jimmylomax »

Mr Mark

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Re: rental property depreciation recapture in retirement?
« Reply #69 on: January 21, 2017, 09:12:29 AM »
Can you avoid recapture by moving into your rental?

Hi, I think I can help clarify this one. As I understand it, the depreciation you claim over time simply acts to lower the effective purchase price of the property (not land) for calculation of any capital gains. When you sell, the capital gain (assuming you don't roll it over into another rental) is calculated according to this artificial lower 'purchase price' (ie the actual purchase price less the accumulated depreciation). It's almost as if the depreciation is like an IRA contribution into the equity of the house - tax deductible, but taxable later.

BUT lets say you move into the house and live in it as your primary residence for at least 2 years. Now if you sell, yes, the depreciation is taken into account. But because it's your primary residence you get $250,000 of tax free capital gain, and if you own it with your spouse they also get $250,000 tax free too. Thus, if there are two of you, you can still get a load of tax free capital gain. If the house less depreciation has still appreciated by more than $500,000k then yeah, pay some taxes you lucky lucky property owner.

No no no no no...

This was changed like 7 years ago.

Do not spread this information, it's wrong.

The gains are prorated based on the amount of time it was a rental versus primary residence.  You don't get the 250/500 exemption anymore, and haven't for a long time.

ARS,
Thanks for raining all over my imaginary tax parade with the truth. Damn you facts!
Yes, the above simplification is totally WRONG, I just so wanted it to be true... however, you do get the 250/500k exemption sort of... but it doesn't indeed extend to the rental period.

Having now done a lot bit more research into this, it seems to work like this (this is a very simplified version - it gets waaaaay more complicated* outside this most basic example, but this gives me a good idea of the main drivers): [NOTE this example has been corrected to account for the correct way to division between rental and residential gain, as pointed out by brooklynguy later in this thread]

Let's assume we buy a property for $250,000 [land $50k, house $200k] and rent it out for 5 years at a monthly rent of 2,500 (the '1% rule') with 50% expense ratio. Later, we then move into the property and live in it for 2 years. The house is then sold for $500,000. We'll assume the land/house ratio stayed the same.

With a 27.5 year flatline depreciation rate (residential) our first 5 years renting were:
- Building value: $200k
- Rent recieved: $30k
- Expenses: $15k
- Depreciation $7272
Taxable income from rent = $7728
Assuming a marginal tax rate of 25%, you'd pay tax of $1932. Hey what a deal right? You earned $15k a year for 5 years and only paid tax at 12.88%! Party on!

BUT, the tax man comes back...

We now sell the house for a sweet $500k net (after all allowable expenses from the sale process). The base value for capital gains however is now less than the actual purchase price (because of that depreciation whether we took it or not) by 5 x $7272 = $36,360.

Realised: $500,000 Adjusted base: $213640 Capital gain: $286,360
Recaptured depreciation is now taken and taxed at a special rate (maximum 25%): so $36,360 taxed at 25% = $9,090 tax
Of the remaining gain 286,360 - 36,360 = 250,000 5/7 is allocated to the rental period = $178571, 2/7 to your personal residence period  = $71428
Remaining rental cap gain: $178571 taxed at 15% = $26785 tax
The cap gain from when you lived there is excluded as you've got an exemption of $250,000, so no tax there.

So you'll owe the tax man $35,875*.

If we'd never rented it out, all that capital gain would have been tax free (because of the 250k exemption), and we'd have cleared $250k. By renting it, we got a total income of $75,000 and a gross capital gain of $250k, but paid a total of $9660 + $9090 + $26785 = $45535 in taxes to clear $279,464. So after taxes, you could say we only made an effective net rental income of $5893/year (279k-250k / 5 years), thereby paying an effective tax rate on that rental income of 60.7%.

Ouch.

So I conclude Sol is correct, the accumulated depreciation (whether you used it or not) is 'recaptured' at a tax rate of 25%*. And the residual capital gain on the property is apportioned between time it was rented vs time it was your residence. That part can't be excluded, and so you'll owe tax at 15% (long term capital gain rate) on that. Living in the property for a couple of years sure helped a bit - protecting $71k from tax - but it didn't really prevent a massive tax hit. Hence the popularity of 1031 exchanges, which defer all those nasty taxes.

sorry for the bad news.

*NOTE II
There are many complications that can effect this simplistic hypothetical. YMMV - especially because of different taxable income levels and capital gains tax rates at the time of renting and selling, accumulated passive activity losses, other capital losses, other rental properties, 1031 exchanges, whether you have active participation in your renting, single vs married, etc etc etc. Keep good records, always include your depreciation in your tax returns, and except in very simplistic situations I think it's likely worth it to consult an experienced real estate tax CPA.
« Last Edit: January 24, 2017, 11:11:08 PM by Mr Mark »
Mr. Mark

arebelspy

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Re: rental property depreciation recapture in retirement?
« Reply #70 on: January 22, 2017, 07:43:05 PM »
Nice post!  Love the illustrative example!  Thanks Mark. :)
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Re: rental property depreciation recapture in retirement?
« Reply #71 on: January 23, 2017, 09:43:45 AM »
Realised: $500,000 Adjusted base: $213640 Capital gain: $286,360
5/7 of that gain is allocated to the rental period $204542, 2/7 to your personal residence period $81,817

Mark, you incorrectly allocated a portion of the gains attributable to the reduction in basis caused by depreciation adjustments (what the tax code calls "unrecaptured section 1250 gains," as Cathy pointed out earlier in the thread) to the residential portion of the gains (i.e., the portion that is subject to the 250/500 personal residence exclusion) rather than allocating all of it to the non-residential portion of the gains.  In other words, you spread the "extra" $36,360 of gains resulting from depreciation over the entire amount of gains, instead of limiting it to the portion of the gains allocable to the time the property was used as a rental.  So you understated the taxes on the rental capital gains (and consequently the effective tax rate on the rental income), assuming everything else about the example is accurate (which I haven't otherwise checked).

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Re: rental property depreciation recapture in retirement?
« Reply #72 on: January 23, 2017, 12:22:48 PM »
I conclude Sol is correct

I just love hearing these words and think they deserve to be quoted, even in a context where it means I get dinged with a 25% tax penalty.

Because really what other incentive to post here do any of us really have?

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Re: rental property depreciation recapture in retirement?
« Reply #73 on: January 23, 2017, 12:40:17 PM »
even in a context where it means I get dinged with a 25% tax penalty

Unfortunately for your sense of vainglory, this statement is incorrect (because, as Cathy already (more than once) explained, the 25% maximum rate is a gift, not a penalty).

sol

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Re: rental property depreciation recapture in retirement?
« Reply #74 on: January 23, 2017, 02:02:56 PM »
even in a context where it means I get dinged with a 25% tax penalty

Unfortunately for your sense of vainglory, this statement is incorrect (because, as Cathy already (more than once) explained, the 25% maximum rate is a gift, not a penalty).

I understand that point, but the fact remains that I will pay a 25% tax rate upon sale in exchange for an annual tax break against income that is completely worthless once my tax rate drops to zero in retirement.

I think my original position hasn't changed since starting this thread, and I should sell our rentals right after we retire.  Otherwise we will continue to lose about a quarter of all additional appreciation each year, while receiving no benefit from ongoing depreciation.

Or have I misunderstood this thread's discussion?

brooklynguy

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Re: rental property depreciation recapture in retirement?
« Reply #75 on: January 23, 2017, 02:19:58 PM »
the fact remains that I will pay a 25% tax rate upon sale in exchange for an annual tax break against income that is completely worthless once my tax rate drops to zero in retirement.

Well, depending on what tax bracket you are in in the year(s) when you sell your rental properties (which will depend, in part, on just how much you profit from those sales), you might pay less than 25%.  But, yes, under a certain set of assumptions, the quoted statement would be correct -- just make sure those are the assumptions you mean to use.  And don't forget that even if your tax rate drops to zero in retirement, the depreciation deduction may still have value to you in ways that I know you are interested in, such as lowering your reportable income for college tuition assistance programs.

(And, of course, one of the assumptions needed to render the quoted statement true is that tax laws do not change in a way that would change the analysis, but that assumption underlies every tax planning strategy we discuss.)

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Re: rental property depreciation recapture in retirement?
« Reply #76 on: January 23, 2017, 06:54:29 PM »
Sol, thanks for starting this thread. I am in your boat and was thinking I was getting shafted also with that 25%. But, from the skimming, it seems that you are taxed at your regular income rate with a max of 25% (hence the word "gift" being thrown around). So, here is my question. Say I stash a year's worth of needed cash into my checking account. Then, sell my rental the next year when I will have income of $0 (living off the checking account). I will have no income in the year that I sell the rental (other than maybe $10k in dividend income). What will my tax rate be on the recaptured depreciation? 0? I sure hope so!

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Re: rental property depreciation recapture in retirement?
« Reply #77 on: January 23, 2017, 08:10:12 PM »
Sol, thanks for starting this thread. I am in your boat and was thinking I was getting shafted also with that 25%. But, from the skimming, it seems that you are taxed at your regular income rate with a max of 25% (hence the word "gift" being thrown around). So, here is my question. Say I stash a year's worth of needed cash into my checking account. Then, sell my rental the next year when I will have income of $0 (living off the checking account). I will have no income in the year that I sell the rental (other than maybe $10k in dividend income). What will my tax rate be on the recaptured depreciation? 0? I sure hope so!

that's exactly my point. I definitely don't think so, but I can't seem to show my steps since I'm having such a hard time working through the worksheets - not if you have any sizable amount of depreciation to deal with... I think the amount of depreciation alone essentially pushes you up into the 15 or 25% bracket by the crazy special formula. I created a marked up spreadsheet tonight I was going to upload to try to show you guys and challenge my rationale, but I didn't quite get it finished. My gut feel is in most situations, even for someone with extremely low taxable income, you should probably bet on exactly 25% toward the "recaptured deprecation" aka unrecaptured section 1250 gains or whatever it's really called. My thinking is the special exception is going to apply for someone with a very small amount of depreciation to deal with and probably zero capital gains on the property.

Mr Mark

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Re: rental property depreciation recapture in retirement?
« Reply #78 on: January 23, 2017, 10:15:04 PM »
Realised: $500,000 Adjusted base: $213640 Capital gain: $286,360
5/7 of that gain is allocated to the rental period $204542, 2/7 to your personal residence period $81,817

Mark, you incorrectly allocated a portion of the gains attributable to the reduction in basis caused by depreciation adjustments (what the tax code calls "unrecaptured section 1250 gains," as Cathy pointed out earlier in the thread) to the residential portion of the gains (i.e., the portion that is subject to the 250/500 personal residence exclusion) rather than allocating all of it to the non-residential portion of the gains.  In other words, you spread the "extra" $36,360 of gains resulting from depreciation over the entire amount of gains, instead of limiting it to the portion of the gains allocable to the time the property was used as a rental.  So you understated the taxes on the rental capital gains (and consequently the effective tax rate on the rental income), assuming everything else about the example is accurate (which I haven't otherwise checked).

Thanks Mr BG, I agree that that's the impact of the calculation, but that's not how I read the worksheet from the IRS https://www.irs.gov/publications/p523/ar02.html#en_US_2016_publink100011708 which has you first subtract the depreciation and then apply the % residence time to the basis revised capital gain.

The difference in the example if it is as you describe would be to transfer about $10 of excuded capital gain to the 15% catagory, so would add yet another 1,500 of tax. :-(

Mr Mark
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Mr Mark

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Re: rental property depreciation recapture in retirement?
« Reply #79 on: January 23, 2017, 10:41:49 PM »
even in a context where it means I get dinged with a 25% tax penalty

Unfortunately for your sense of vainglory, this statement is incorrect (because, as Cathy already (more than once) explained, the 25% maximum rate is a gift, not a penalty).

I understand that point, but the fact remains that I will pay a 25% tax rate upon sale in exchange for an annual tax break against income that is completely worthless once my tax rate drops to zero in retirement.

I think my original position hasn't changed since starting this thread, and I should sell our rentals right after we retire.  Otherwise we will continue to lose about a quarter of all additional appreciation each year, while receiving no benefit from ongoing depreciation.

Or have I misunderstood this thread's discussion?

Sol, you are going to pay 25% tax on the accumulated depreciation (claimed or not) whether you sell just before you retire or afterwards. So after you retire, indeed the deduction against an income tax rate of less than 25% is going to hurt you later if you sell. However, if you have accumulated passive activity losses during your time renting (this is why you must claim the depreciation even if you think you don't need it because the IRS will recapture the depreciation whether you actually claimed it or not), that carried forward passive loss can be somehow be claimed back as an offset if you sell basically all your rentals.

But the IRS worksheets are a complex mess. I guess my takeaways from this thread are:
- a good CPA that specialises in real estate and rental taxation is well worth paying as it seems very easy to f$%k it up when doing it yourself.
- you better claim the depreciation every year you're renting whether you think you need it or not, so you can roll forward 'passive activity losses'
- living in the ex-rented house for a couple of years and involking the 250/500k exemption does not get you around a big piece of the capital gains taxes due on the appreciation (super glad to have learned that one!)
- the tax man will be looking for his 25% of all that previous depreciation if you sell and do not roll into another rental via 1031
- it may be a good idea to factor in the future tax effects when looking at the economics of renting, as the taxes might make a HUGE difference to your real net return on capital. The simplicity of the '1% rule' may indicate something that looks like a good investment, but is actually a total loser compared to say, a simple REIT.
Mr. Mark

brooklynguy

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Re: rental property depreciation recapture in retirement?
« Reply #80 on: January 24, 2017, 07:14:27 AM »
but that's not how I read the worksheet from the IRS https://www.irs.gov/publications/p523/ar02.html#en_US_2016_publink100011708 which has you first subtract the depreciation and then apply the % residence time to the basis revised capital gain.

The Publication 523 worksheets subtract the total amount of depreciation from the total gain (which already includes any portion resulting from a reduction in basis due to depreciation adjustments) before calculating the residence/non-residence breakdown that is used to determine the portion of the gains that is subject to the personal residence exemption (see line 3b of the "How To Figure Your Taxable Gain or Loss Worksheet").  This has the effect of allocating the entire amount of gains attributable to depreciation adjustments to the rental portion of the gains (and none of it to the residential portion of the gains).

fishnfool

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Re: rental property depreciation recapture in retirement?
« Reply #81 on: January 24, 2017, 09:25:42 AM »
This thread has me thinking that paying off this rental from tax free exemptions we get selling our primary home makes even less sense. I'm now leaning towards investing in the markets at that point or possibly buying another house?

arebelspy

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Re: rental property depreciation recapture in retirement?
« Reply #82 on: January 24, 2017, 01:40:00 PM »
This thread has me thinking that paying off this rental from tax free exemptions we get selling our primary home makes even less sense. I'm now leaning towards investing in the markets at that point or possibly buying another house?

Depreciation has nothing to do with a mortgage.  Depreciation is the same if it's paid off, or has a mortgage.
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Mr Mark

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Re: rental property depreciation recapture in retirement?
« Reply #83 on: January 24, 2017, 10:43:20 PM »
but that's not how I read the worksheet from the IRS https://www.irs.gov/publications/p523/ar02.html#en_US_2016_publink100011708 which has you first subtract the depreciation and then apply the % residence time to the basis revised capital gain.

The Publication 523 worksheets subtract the total amount of depreciation from the total gain (which already includes any portion resulting from a reduction in basis due to depreciation adjustments) before calculating the residence/non-residence breakdown that is used to determine the portion of the gains that is subject to the personal residence exemption (see line 3b of the "How To Figure Your Taxable Gain or Loss Worksheet").  This has the effect of allocating the entire amount of gains attributable to depreciation adjustments to the rental portion of the gains (and none of it to the residential portion of the gains).

Ah, gotcha. Thanks Brooklynguy. I'll go back and edit the example to reflect that so it doesn't hang around like an abandoned drift net in the internet sea...
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Re: rental property depreciation recapture in retirement?
« Reply #84 on: October 03, 2017, 10:09:42 AM »
Wow... great thread.  Apologies for bringing this one back from the dead... but I'm back on the forum after a very long time away.
There’s some good info buried in this thread, but it seems misunderstanding persists about the 25% tax on "depreciation recapture".

Before I dig into the details about the evaluating the value of rental property depreciation in retirement vs during working years I’ll point out that the tax deferment value provided by the depreciation deduction is just ONE benefit of RP investing. RP investment still offers income, potential appreciation, and can be leveraged with the cost of financing fully deductible. So, I don’t share the OP’s view that a RP investment should necessarily be disposed of just because the depreciation component can’t be fully realized.
With that said… what are the takeaways from this thread?

1) Depreciation recapture (unrecaptured section 1250 gain) is NOT taxed at 25%, but is recognized as income and taxed at *up to* 25%. (Thanks Cathy).  The myth of an unavoidable 25% tax seemed to persist till the end of the thread despite Cathy’s posts.

2) Sale of rental property triggers the depreciation recapture AND the capital gain that both get claimed in the same tax year. The practical implication of that takeaway is: Especially in a year where there is already other income, the combination of dep recaptured and capital gains, for a property that has been held for a long time, may very well "push the taxpayer into the next bracket".

So what's a mustachian to do based on those takeaways?

The short answer:

If you are determined to sell, plan for the sale of a rental property in early retirement the same way you would plan to use the Roth Conversion ladder.  Except, since there is no ladder to ease the transition, you must ensure the "ledge" that you jump down from is low enough to be manageable all in one year. Basically, selling your rental property in an early retirement year where you purposefully recognize little or no other income is the best you can do. Income from the sale is "protected" by standard deductions, exemptions, etc. Note that this strategy doesn't necessarily focus on maximum wealth accumulation, but rather on tax efficiency. But if you've already made the decision to sell, minimizing the impact is the best you can do.

More nuanced discussion:

If you are aware of your “accumulated depreciation” for a given property and also know (estimate) the capital gain you’ll realize, you have enough info to run through a tax calculator to know your exact tax burden. I’ve run several scenarios and confirmed it’s possible to realize a combination of capital and unrecaptured section 1250 gain in the $100K range while maintaining an effective federal tax rate WAY below 25%. Even when allocating, say, $90K to section 1250 and only $10K to capital gains this holds true.

Unfortunately, taxes are complicated. A sale of RP with capital gains and unrecaptured 1250 gain is going to require the Qualified Dividends and Capital gain tax worksheet. The back of the napkin calculations just don’t cut it when there are so many variables at play. 

The kicker:

Speaking of variables.  One I didn’t see mentioned in this thread was the AMT (alternative minimum tax). After all, most mustachians probably don’t anticipate dealing with it in their retirement years.

Even if we cast aside the persistent myth about mandatory 25% tax on unrecaptured 1250 gain and recognize that income is reported as ordinary income (with a CAP of 25%), there’s still a chance that all those calculations get thrown out the window if income (even if it’s all from capital and other gains) is high enough to trigger the AMT.  Which makes it even more important (for those wishing to sell property before death) to keep an eye on the total potential gains (capital + recapture) + other income, and know which tax thresholds they may be “pushed over”.

If you are determined to sell a rental at some point in retirement, this AMT threshold may be the most important to know.

In real estate, transaction costs can throw a wrench in many plans. But for those wanting to stay invested in rental real estate, but also wanting the option of selling before death, it could actually make sense to sell one rental in a low-income early retirement year early enough to stay below the AMT threshhold, and buy another with the plan to dispose of it before it’s recapture and capital gains eclipse that threshold (or others in the tax code) to provide the most tax-efficient way to stay invested in real estate longer into early retirement.

I’ll stop here.  Maybe some tax accountants can weigh in on this strategy overall or give more specifics about staying below the AMT trigger when most or all income is from capital and other gains.

sol

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Re: rental property depreciation recapture in retirement?
« Reply #85 on: October 03, 2017, 11:26:09 AM »
Good info, JH, thanks for chiming in.

The AMT angle deserves further scrutiny.  It looks pretty easy to exceed the AMT minimum with cap gains and depreciation recapture if you've held the property for a while, and virtually guaranteed if you need to sell more than one property in a single tax year.

SuperSecretName

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Re: rental property depreciation recapture in retirement?
« Reply #86 on: October 03, 2017, 12:13:59 PM »
so, if I can sum all of this up simply it would be:

1 - depreciation you took over the life of the rental gets paid back at your normal income rate, but max of 25%.  if it's a large amount, it could push you into the next bracket
2 - cap gains are proportional to the amount of time it's a personal residence vs rental (when trying to use the 250/500 cap gain exclusion).

Is that right?
« Last Edit: October 03, 2017, 12:23:04 PM by SuperSecretName »

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Re: rental property depreciation recapture in retirement?
« Reply #87 on: October 03, 2017, 02:39:34 PM »
^^  and, if you can, plan the sale of your property (that has increased in value) when your annual income is anticipated to be quite low.    (or alternatively, when you have a lot of capital loss to counter the capital gains, which will also help).

johnhenry

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Re: rental property depreciation recapture in retirement?
« Reply #88 on: October 03, 2017, 03:26:35 PM »
Good info, JH, thanks for chiming in.

The AMT angle deserves further scrutiny.  It looks pretty easy to exceed the AMT minimum with cap gains and depreciation recapture if you've held the property for a while, and virtually guaranteed if you need to sell more than one property in a single tax year.



Yes... I'd say how "easy" it is to exceed the AMT depends on the perspective of the investor.  I have the luxury of RE investing in the midwest and the majority of my SFH properties are under $50K.  Even if I held one of those for 25 years so that it was nearly fully depreciated AND had doubled in value, I'd be looking at ~$50K in ordinary income + $50K in capital gains.  And yes... dealing with lower priced units like that the only way you'd ever be able to unload more than one in a year. 

If you are invested in a $500K residential structure, you'd be accumulating about $18200 in depreciation per year.... less than 3 years to get to $50K accumulated.  And then, appreciation of the property has a bigger effect on the raw number.  So if you were banking on being able to handle a 10% increase, but had the "bad luck" of selling for 12% above what you paid, it could be enough to trigger the AMT if you didn't have enough cushion built in.

But cut $500K in half to $250 and that will double your time frame.

So yea... investing is lower priced "units" increases your flexibility and widens the "window" during which you could sell and implement this strategy of shielding your gain income while staying below the AMT trigger.  The higher the price of the individual unit, the smaller your window because one year of depreciation and/or a small % in capital gain can be such a big dollar amount.  Other Capital expenditures that increase depreciation also factor in and are likely to be bigger with more expensive units.

But that certainly doesn't mean the strategy isn't feasible for properties in $150K to $300K range. 

Once you know your income limit to stay under the AMT trigger, just divide that by depreciation your property accumulates in one year.  That's the absolute MAX # of years you could hold the property.  From there you'd work backwards, subtracting a year or 2 to be safe and then estimating the max your property would appreciate in that time.  That number of years is realistically the longest you'd want to plan to hold the property.






johnhenry

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Re: rental property depreciation recapture in retirement?
« Reply #89 on: October 04, 2017, 09:18:17 AM »
I've been running some more test scenarios through the tax software to look at the tax consequences of selling a RP in early retirement.  Results are based on MFJ, with only 2 in the household (no kids), and little or no other income.  Sometimes I run the scenarios with $0 other income ... usually I run it with about $5K in other income to represent the potential interest, dividends, capital gains from taxable investments in ER other than the transaction in question.

It seems that besides the AMT... there are a couple other threshholds to be aware of. 

1) If your income (AGI, line 38) is above about $155K, the per-person exemption starts to get stepped down from the max of $4050 if AGI was below that amount.

2) If your MAGI is over $250K you may need to file form 8960 - Net Investment Income Tax which taxes income above that level at 3.8%

clarkfan1979

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Re: rental property depreciation recapture in retirement?
« Reply #90 on: October 08, 2017, 01:14:18 AM »
My wife's grandparents have a rental in Denver. They just moved back into it as their primary residence after fully depreciating for 30 years as a rental. They claim that if they live in  it for two years the depreciation clock resets and they can fully depreciate it a second time. They will give it to their heirs when they pass, avoiding all capital gains tax.

Goldielocks

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Re: rental property depreciation recapture in retirement?
« Reply #91 on: October 08, 2017, 10:07:18 AM »
My wife's grandparents have a rental in Denver. They just moved back into it as their primary residence after fully depreciating for 30 years as a rental. They claim that if they live in  it for two years the depreciation clock resets and they can fully depreciate it a second time. They will give it to their heirs when they pass, avoiding all capital gains tax.

I know capital gains tax on prinicipal property works differently in the US, but do you mean depreciation recapture or Capital gains tax, or maybe both?

CareCPA

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Re: rental property depreciation recapture in retirement?
« Reply #92 on: October 08, 2017, 08:13:27 PM »
My wife's grandparents have a rental in Denver. They just moved back into it as their primary residence after fully depreciating for 30 years as a rental. They claim that if they live in  it for two years the depreciation clock resets and they can fully depreciate it a second time. They will give it to their heirs when they pass, avoiding all capital gains tax.
1. Depreciation does not reset merely by living there for two years. You would need an arms length sale.
2. The heirs will most likely get a stepped up basis, and would be able to depreciate it. This value would get captured and potentially taxed in estate/inheritance taxes, but would not be subject to income taxes (i.e capital gains) like you said.
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.