Real Estate Investing: Are You Aware Of The Recapture Tax?

By Author: James Kobzeff
Total Articles: 44
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You were probably already aware of the capital gains tax when you started real estate investing and long before you purchased your first rental property investment. That is, that you might be required to pay a capital gains tax to the Feds in the year when you outright sold your investment property unless you involved a Section 1031 tax deferred exchange.

You might not know, however, about the depreciation recapture tax you will also have to pay the Feds. Many real estate investors do not, and subsequently are in for an unpleasant surprise when they sell their investment real estate and discover that their sales proceeds are lower than anticipated by virtue of a higher federal obligation.

What is depreciation recapture tax?

First, understand that capital gains tax and recapture tax occur only when investment real estate is sold after one year of ownership. Profits on an investment property sold one year or less is classified as a short-term gain and taxed as ordinary income. Capital gains and the recapture tax apply only to investment property held for more than one year. In real life, here is ...
... how it works.

When you sell an investment property you have held for more than one year and have a recognized gain, the IRS, in addition to charging you a capital gains tax, will also tax you for the accumulated depreciation you took during the years you owned the property.

Say, for instance, you sell an office complex after ten years of ownership and make a taxable profit (or gain) of $300,000 and during that time took $30,000 in depreciation. The result is that you must pay two taxes: First, the recapture tax on the depreciation, and then the capital gains tax on the remainder.

Here is where it gets ugly.

The rate for recapture tax is currently higher than the capital gains tax rate (25% compared to 15%). As a result, you pay 10% more on the depreciation then you do if the recapture tax did not exist and your full profit was simply taxed as capital gains. This might be acceptable if you plan ahead for it, but extremely disappointing when you discover at tax time that you owe the IRS $3,000 more then you anticipated.

If you are engaged in real estate investing, and were not aware of the depreciation recapture tax, you better consult your tax attorney or accountant for more information. You certainly don't want to sell your investment real estate and learn about it the hard way.
James Kobzeff is the developer of ProAPOD - leading real estate agent software solutions since 2000. Create rental property cash flow analysis and marketing presentations in minutes! Easy and affordable. Go to => www.proapod.com