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George Saenz, the Tax Talk columnistAccelerated cost recovery system on rental

Dear Tax Talk,
I purchased a rental condo in August 1981 for $25,000. I used ACRS to depreciate $20,000 of the property value over 15 years. That left my cost basis at $5,000. I am planning to sell the property this year for $100,000 and need to understand how the profit will be taxed (income and/or capital gains).
-- Alexander

Dear Alexander,
Some things are not forever; however, depreciation recapture is. The accelerated cost recovery system, or ACRS, is applied to property placed in service between 1981 and 1986. It was part of Reagan's tax reforms when he took office. You could depreciate on an accelerated basis the full cost of a building in 15 years and finance and pay it over 30 or more years. This was a leveraged tax benefit. It was responsible for a large building boom that later left savings and loans holding the bag on vacant buildings that were created for their rapid tax write-offs.

After 1986, real property was no longer eligible for accelerated depreciation, and currently, residential and commercial properties are depreciated over 27 and 39 years, respectively.

Residential property under ACRS that was depreciated on an accelerated basis (there was straight-line ACRS) used to have a portion that was considered ordinary income upon a sale. The ordinary-income portion would have been the amount of accelerated depreciation that exceeded straight-line at the time of sale. Hence, if the building was sold prior to it being fully depreciated, part of the gain would have been ordinary income.

Of course, now that the building's cost is fully depreciated, less the amount that you assigned to land ($5,000 that was not depreciable), there is no portion that is ordinary income. In other words, at the end of the 15 years, accelerated and straight-line depreciation are the same in total. The $20,000 in depreciation is recaptured at the maximum rate of 25 percent, and the remaining gain of $75,000 is taxed at the long-term capital gains rate of 15 percent.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: Aug. 24, 2006
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