Are you struggling to wrap your head around depreciation recapture? If so, you’re not alone.
When running your real estate business, you can account for the wear and tear of your property and any furnishings and appliances you own via depreciation. You can divide the costs associated with these items over several years through depreciation based on the schedules of asset classes that the internal revenue service (IRS) publishes.
Depreciation recapture refers to the portion of a gain you realize from selling a rental property taxed as ordinary income instead of capital gain. In other words, when you sell your property, the IRS taxes you on your depreciation deductions.
Still confused? That’s okay. In this post, we’ll show you how depreciation recapture works (and include examples), how to calculate it and tell you if it can be avoided.
Here’s everything you need to know about depreciation recapture:
What is Depreciation?
Before we dive into depreciation recapture, you should first know how depreciation works. Investment properties naturally degrade over time due to use, weathering, and general wear and tear. It just happens. Your roof ages, wood slowly decays, and your appliances don’t work as well as they once did.
Luckily, there are tax benefits for depreciation assets, which can help you save money. The IRS lets real estate investors deduct their property’s cost for a set time: 27.5 years for residential real estate and 39 years for commercial real estate.
Unlike other items, you can deduct, like a car, or a computer, which you write off as a business expense, your property will likely appreciate in value over time as long as you take care of it. In that sense, depreciation is often called a “phantom deduction” because you’re not losing anything, but you still get to deduct the cost. Put another way; real estate investors can reap the benefits of both depreciation and appreciation.
To qualify for…