Confused About Depreciation Recapture Tax

[allanb]

California, my wife inherited an office building in 2008. She had it appraised a month after her father's death, It appraised for $800,000 and had a mortgage on it for $450,000. 5 years ago she paid the mortgage off. She would like to sell it, possibly to the current Tenant. It's valued at about $1,250,000. We are both on a fixed income that in 2024 will be approximately AGI $85,000, I believe, as we will be under the approximate $94,000 AGI she will have zero Capital Gains Tax on the sale of the property. Her straight-line depreciation on the property has been approximately $20,000 per year for 15 years. Will she have to pay the California Depreciation recapture tax of 9.3% and the federal depreciation recapture rate of 25% on the approximate $300,000 that she has currently depreciated the property at the time she sells it, or am I missing something in my calculations?

 

[LdiJ]

California, my wife inherited an office building in 2008. She had it appraised a month after her father's death, It appraised for $800,000 and had a mortgage on it for $450,000. 5 years ago she paid the mortgage off. She would like to sell it, possibly to the current Tenant. It's valued at about $1,250,000. We are both on a fixed income that in 2024 will be approximately AGI $85,000, I believe, as we will be under the approximate $94,000 AGI she will have zero Capital Gains Tax on the sale of the property. Her straight-line depreciation on the property has been approximately $20,000 per year for 15 years. Will she have to pay the California Depreciation recapture tax of 9.3% and the federal depreciation recapture rate of 25% on the approximate $300,000 that she has currently depreciated the property at the time she sells it, or am I missing something in my calculations?

Well, the 25% rate you are talking about is a cap. Federal depreciation recapture is taxed at ordinary income tax rates but caps out at 25%. Based on the sales price of the asset it will end up being pretty much the 25% anyway, but it is a cap. Yes, the depreciation has to be recaptured.

You are also wrong that there will be zero capital gains. The income level you are talking about includes the capital gain, therefore you will be way over the income level for the zero capital gains tax rate.

You might want to consider using a tax professional for this year. The penalties if you get it wrong could be somewhat harsh.

 

[allanb]

Well, the 25% rate you are talking about is a cap. Federal depreciation recapture is taxed at ordinary income tax rates but caps out at 25%. Based on the sales price of the asset it will end up being pretty much the 25% anyway, but it is a cap. Yes, the depreciation has to be recaptured.

You are also wrong that there will be zero capital gains. The income level you are talking about includes the capital gain, therefore you will be way over the income level for the zero capital gains tax rate.

You might want to consider using a tax professional for this year. The penalties if you get it wrong could be somewhat harsh.

Yeah, got that on the tax professional, I usually start on this forum because the advice helps me formulate questions for a tax professional. Right now it doesn't look really good for selling the property. May have to look at a 1031 tax exchange.

 

[LdiJ]

Yeah, got that on the tax professional, I usually start on this forum because the advice helps me formulate questions for a tax professional. Right now it doesn't look really good for selling the property. May have to look at a 1031 tax exchange.

I understand that you don't want to pay a lot of tax, but you have to weigh the benefits of selling separately from the tax consequences. If the real estate market goes through a bust, you may lose more than you save in taxes if you avoided selling.

 

[Taxing Matters]

I understand that you don't want to pay a lot of tax, but you have to weigh the benefits of selling separately from the tax consequences.

I disagree. I tell clients they should not just focus on the gain or the tax. The two go together in determining what money ultimately winds up in their hands. A lot of them just focus on the tax they'll pay in making their decision, and that doesn't give them a complete picture what the transaction will do for them.

If the real estate market goes through a bust, you may lose more than you save in taxes if you avoided selling.

That's true. Unfortunately accurately predicting what will happen years from now is purely speculative. Thus, a person if left to figure out what they believe to be most likely to happen with the information presently available.

 

[LdiJ]

I disagree. I tell clients they should not just focus on the gain or the tax. The two go together in determining what money ultimately winds up in their hands. A lot of them just focus on the tax they'll pay in making their decision, and that doesn't give them a complete picture what the transaction will do for them.



That's true. Unfortunately accurately predicting what will happen years from now is purely speculative. Thus, a person if left to figure out what they believe to be most likely to happen with the information presently available.

Actually, that was more or less what I was trying to say. That both things matter as well as the whole picture. However I do think that both things should be looked at separately before they are looked at together. That way you get a clearer picture of the positives and negatives of each before meshing things together.

 

[Taxing Matters]

May have to look at a 1031 tax exchange.

That simply defers the capital gain. Don't look at just the income tax side of this in your decision. A § 1031 exchange is great if you want to hold investment property and think it will increase in value to make it worthy as an investment taking into account what you'd pay for costs of upkeep and real estate tax. Owning real estate is also an illiquid investment, meaning it may take some considerable time to sell it and get a price that is reasonably near the fair market value. So if you need to get cash quickly out of the property at some point you'd be left with either getting a mortgage for the money or selling it at a fire sale price. If you have other liquid assets to cover most of the things that may happen to you where you'd need to raise money quickly then real estate can be a good investment, at least in some markets. You still have to pay to maintain whatever property you get and the real estate taxes all the time you hold the property. If the gain on your investment is good enough that those costs won't make the property an unattractive investement compared to alternative investments, that's great. That's what you want. But if another investment is more liquid, doesn't have the same (or more) ongoing costs while you hold it, and will ultimately get you more in your pocket, taking into account having to pay the tax on the gain on that (hopefully) higher price, that's the one I'd pick and just sell the real estate now and take the tax hit. My point here is simply that the entire financial impact you'll have, taking everything into account, is what I'd focus on.