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DEPRECIATION RECAPTURE EXPLAINED

Educational guide to how depreciation recapture generally works on a rental or commercial property sale

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Depreciation recapture is one of the more commonly misunderstood parts of selling rental or commercial real estate. This is a general educational overview of how it generally works for Las Vegas investors. It is not tax, legal, or investment advice, and every sale should be reviewed with a tax advisor before closing.

Why Depreciation Is Recaptured

Real estate held for rental or business use is generally eligible for annual depreciation deductions, which generally reduce taxable income each year the property is owned. Because those deductions generally lower the property's cost basis over time, selling the property generally produces a larger taxable gain than if no depreciation had been claimed, and the portion of that gain attributable to depreciation is generally recaptured and taxed on sale, whether or not the deductions actually reduced the owner's tax bill in earlier years.

The Federal Rate on Recaptured Depreciation

For real property, the recaptured amount is generally taxed as unrecaptured Section 1250 gain, at a federal rate generally capped at twenty five percent, which is generally higher than the zero percent, fifteen percent, or twenty percent rates that generally apply to the remaining appreciation portion of the gain. This generally means two properties with the same total gain can generally produce different tax bills depending on how much depreciation was claimed.

Cost Segregation and Its Effect on Recapture

Some Las Vegas commercial property owners generally use a cost segregation study to accelerate depreciation on components of a building, which generally increases deductions in early years of ownership. This generally increases the amount of depreciation subject to recapture on a later sale, so the accelerated benefit generally needs to be weighed against the recapture exposure it generally creates, particularly for an owner who expects to sell within a shorter holding period.

Deferring Recapture With a 1031 Exchange

A 1031 exchange generally allows both the appreciation gain and the depreciation recapture to be deferred together, as long as the sale proceeds are reinvested into a qualifying replacement property within the applicable deadlines. The deferred recapture generally carries forward into the replacement property, meaning it generally is not permanently avoided but generally continues to be deferred as long as the investor keeps exchanging into qualifying real estate. This overview is general and educational, and any specific recapture calculation should generally be confirmed with a tax advisor.

Recapture on Long Held Las Vegas Rental Property

Investors who have owned a Las Vegas rental home or small commercial building for many years generally have accumulated a correspondingly larger depreciation recapture exposure, since the annual deductions generally compound the longer the property is held. This generally makes long held property an especially common candidate for 1031 planning, since the recapture tax that would otherwise come due on a straightforward sale is generally large enough to make deferral worth exploring, particularly for an investor who intends to remain invested in real estate rather than needing the cash from the sale.

Recapture Differences Between Residential and Commercial Property

Recapture calculations generally apply the same underlying framework to residential rental property and commercial property, though commercial buildings that used a cost segregation study to accelerate depreciation on certain components generally carry a more layered recapture calculation than a straightforward residential rental depreciated on a standard schedule. An investor who used cost segregation on a Las Vegas commercial property generally benefits from having a tax advisor calculate the recapture exposure well before a planned sale, since the components depreciated on different schedules generally need to be tracked and recaptured according to their own applicable rules.

Why Some Investors Overlook Recapture When Planning a Sale

It is common for an investor to focus primarily on the appreciation portion of a gain when estimating taxes on an upcoming sale, since appreciation is generally the more visible and intuitive part of the calculation, while the recapture component generally requires pulling depreciation records that may not be top of mind. A Las Vegas investor planning a sale generally benefits from asking a tax advisor to prepare a full projection covering both components well in advance, so that the decision between a straightforward sale and a 1031 exchange is generally based on the complete tax picture rather than an incomplete estimate.

Frequently Asked Questions

DEPRECIATION RECAPTURE EXPLAINED FAQS

What is depreciation recapture on rental property?

Generally the portion of a sale gain attributable to depreciation already claimed, which is generally taxed separately from the remaining appreciation gain.

What is the federal rate on recaptured depreciation?

Generally capped at twenty five percent for unrecaptured Section 1250 gain on real property, which is generally higher than typical long term capital gains rates.

Does depreciation recapture apply even if the owner never actually benefited from the deductions?

Generally yes. Recapture generally applies to depreciation that was allowed, whether or not it was actually claimed on prior returns.

Does a cost segregation study increase recapture exposure later?

Generally yes, since it generally accelerates depreciation deductions, which generally increases the amount subject to recapture on a future sale.

Can a 1031 exchange defer depreciation recapture?

Generally yes, a 1031 exchange generally defers both the recapture and the appreciation gain together when the proceeds are reinvested into a qualifying replacement property.

Does depreciation recapture apply to raw land?

Generally no, since raw land generally is not a depreciable asset, so a sale of raw land generally does not generate a recapture component, only the appreciation portion of the gain.

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