Author Topic: Case Study: Hair on Fire situation + painful depreciation recapture  (Read 1250 times)

finallyfrugal

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Hubby and I own a rental property that we bought when we were young and dumb and didn't realize all the tax implications of what we were doing. The realtor who "helped" us must have been an idiot and only told us the upside of buying a rental property in the GO Zone after all the hurricanes, not the downsides. The house has fallen in value ever since we bought it (from $145K to $125K), it is geographically far away, and is managed by a property manager. We are just flushing money down the toilet to manage the vacancies, maintenance, etc.

At this point we want to stop hemorrhaging money on this property and have listed it. It is cashflow negative on a monthly basis by $50 (it used to be $200), and that is before vacancies and maintenance, which are high. In trying to understand the tax implications, I now see that we will owe a shit ton of money due to depreciation recapture. Since it was a Go Zone property we took a 50% depreciation in year 1...I want to punch myself in the face for not understanding the tax implications of this on selling the property. At this point, it seems like we can either continue to lose money each year, or bite the bullet and pay $19K in depreciation recapture, plus $2500 in state taxes. That is pretty much all our emergency fund right there (well we'd have a little left over). Everything else is tied up in retirement accounts (about $300K). I just want to cut bait and deal with the loss and move on, even though it is a super painful and expensive life lesson.

What would you do? We are both 39, and have suffered through owning this property for the past 9 years. Would you bite the bullet and just sell at a loss to be rid of it, or continue lugging the anchor down the road...?  At this point, since we signed the realtor contract for 6 months, I guess we are on the hook for her fee if we pull the plug before the contract is up.

I hope reading this makes you feel better about all your life choices! At least you didn't make this decision! haha

waltworks

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #1 on: April 03, 2018, 10:33:22 AM »
Sell it and take your losses as a lesson learned.

-W

finallyfrugal

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #2 on: April 03, 2018, 11:41:58 AM »
Thanks, Waltworks -- I feel the same. So painful. But at least it will be over and we will never make the same mistake!

waltworks

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #3 on: April 03, 2018, 12:24:19 PM »
If it helps, the depreciation is money you *didn't* pay in taxes in previous years. So you're not technically losing anything paying it back.

-W

jwright

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #4 on: April 03, 2018, 12:52:59 PM »
Are you saying the tax on depreciation recapture is $19k or that is the amount of depreciation taken? 

If you sell at a loss depreciation recapture is not a factor.

finallyfrugal

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #5 on: April 03, 2018, 01:09:57 PM »
If it helps, the depreciation is money you *didn't* pay in taxes in previous years. So you're not technically losing anything paying it back.

-W

yes -- I am doing my best to be grateful that we had the depreciation tax deduction for many years. Now we must pay the piper! It's just a big chunk that feels like a gut punch.

Are you saying the tax on depreciation recapture is $19k or that is the amount of depreciation taken? 

If you sell at a loss depreciation recapture is not a factor.

The tax owned on the depreciation will be $19K. And from what I can tell, even though we are selling at a loss, we still have to pay the depreciation recapture. We just avoid capital gains from any appreciation since it is a loss.

jwright

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #6 on: April 04, 2018, 07:38:11 AM »
If it helps, the depreciation is money you *didn't* pay in taxes in previous years. So you're not technically losing anything paying it back.

-W

yes -- I am doing my best to be grateful that we had the depreciation tax deduction for many years. Now we must pay the piper! It's just a big chunk that feels like a gut punch.

Are you saying the tax on depreciation recapture is $19k or that is the amount of depreciation taken? 

If you sell at a loss depreciation recapture is not a factor.

The tax owned on the depreciation will be $19K. And from what I can tell, even though we are selling at a loss, we still have to pay the depreciation recapture. We just avoid capital gains from any appreciation since it is a loss.

Your last statement is incorrect.  However, because your adjusted basis is less than FMV you are not actually selling at a loss and that's why you have to deal with recapture. 

If you sell at a price below the depreciated value (a loss), there is no tax assessed including no depreciation recapture.

finallyfrugal

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #7 on: April 04, 2018, 09:08:09 AM »
Are you saying the tax on depreciation recapture is $19k or that is the amount of depreciation taken? 

If you sell at a loss depreciation recapture is not a factor.

The tax owned on the depreciation will be $19K. And from what I can tell, even though we are selling at a loss, we still have to pay the depreciation recapture. We just avoid capital gains from any appreciation since it is a loss.
[/quote]

Your last statement is incorrect.  However, because your adjusted basis is less than FMV you are not actually selling at a loss and that's why you have to deal with recapture. 

If you sell at a price below the depreciated value (a loss), there is no tax assessed including no depreciation recapture.
[/quote]

You are correct! If we sold the property for less than $79K, we would not have to repay the depreciation tax credits. But we'd owe out of pocket on the mortgage...

It's a tricky situation all around, but we do have an offer that we are going to take. A bird in hand is worth two in the bush! I am ready to do my penance and move on...

tralfamadorian

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #8 on: April 04, 2018, 12:05:47 PM »
One option to consider is to look into a 1031. You can roll that depreciation into a new cash flowing property.

finallyfrugal

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Re: Case Study: Hair on Fire situation + painful depreciation recapture
« Reply #9 on: April 11, 2018, 01:26:48 PM »
One option to consider is to look into a 1031. You can roll that depreciation into a new cash flowing property.

Thanks for this suggestion, but at this point, we are going to just get back to basics in terms of money management, saving, and maxing out retirement accounts before attempting anything else RE related. :)