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Columns: Tax Talk
George Saenz, CPA   Expert: George Saenz, CPA
Tax Talk
Tax rate on rental's recaptured depreciation
Tax Talk

Selling depreciated real estate

Dear Tax Talk,
We have a house that has been rented for about 29 years. It has been fully depreciated. We understand that the depreciation is recaptured and taxed. We had been told that depreciation recaptured after May 6, 1997 is taxed at a 25-percent federal rate. Is there a different rate that applies to depreciation taken prior to this date?
-- Diana

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Dear Diana,
The tax law allows taxpayers to recover the cost of their investment in productive assets through annual depreciation deductions. The deduction offsets current income from the productive activity. This offset can save you tax based on your marginal tax rate, which over the years you have had the property has varied. The current maximum marginal rate is 35 percent.

When you sell a property, part of the gain is considered a recapture of depreciation deductions that were allowed or should have been allowed and claimed. See my prior article that discusses allowed or allowable depreciation deductions.

The maximum tax on depreciation recapture is 25 percent, whereas the maximum tax on long-term capital gain is 15 percent. Both tax rates can be less, depending on your marginal tax rate, which is a function of your taxable income.

Depreciation recapture is the difference between your cost basis and your adjusted basis. Your adjusted basis is the cost basis less all depreciation allowed or allowable. Long-term capital gain is the difference between your selling price and your cost basis for assets owned for more than one year.

For example, if the property cost you $30,000 originally and you depreciated it down to zero (you shouldn't have depreciated the part allocable to land but let's assume you did) your adjusted basis is zero. If you sell the property for $100,000 net, $70,000 would be long-term capital gain and $30,000 would be recapture.

The May 6, 1997, reference refers to principal residences. A loophole exists that would allow you to reoccupy that rental home for two years as your principal residence. By doing so, you can qualify the property for the $250,000 gain exclusion on the sale of a principal residence. The law states that in this situation part of the gain attributable to depreciation after May 6, 1997, cannot be part of the $250,000 exclusion.

Bankrate.com's corrections policy -- Posted: May 19, 2008
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