Just Sold Your Investment Property? Are You Prepared to Pay the Recapture Tax?

Before you purchased your rental property investment, you were probably already well aware of the capital gains tax, and the fact that you might be required to pay it to the Feds in the year when you outright sold the property (without involving a Section 1031 tax deferred exchange).

What you might not have known about, however, is the depreciation recapture tax you will also have to pay the Feds, and as a result may be in for an unpleasant surprise when you discover that your sales proceeds are lower than you anticipated by virtue of a higher federal tax 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 you sell an office complex after ten years of ownership and make a taxable profit (gain) of $300,000, but during that time took $30,000 in depreciation. 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 recapture tax rate is currently higher than the capital gains tax rate (25% compared to 15%). As a result, you pay 10% more tax on the depreciation then you do if the recapture tax did not exist and your full profit was simply taxed as capital gains. Perhaps otherwise acceptable if you plan ahead for the recapture tax, but extremely disappointing discovering at tax time that you owe the IRS $3,000 more then anticipated and in turn must say goodbye to the high-definition plasma screen television you planned to purchase with your sale proceeds.

Unfortunately, this scenario has occurred more then once to real estate investors who were not aware of the depreciation recapture tax. That is why we mention it. We hope that you fare better.

About the Author

James R Kobzeff is a real estate broker and developer of ProAPOD Real Estate Investment Software - Rental property cash flow, rate of return, and profitability analysis. Real Estate Investor Software - So those just starting to invest in real estate can determine whether the property makes money or not, and how much. Financial Calculator - Compute hundreds of mortgage, time value, and cash flow computations in seconds! Preview reports and screen shots at http://www.proapod.com

Other articles by James Kobzeff

Tax-Deferred Exchanges - What Real Estate Investors Should Know - by James Kobzeff
Many requirements must be met to qualify for an exchange for tax deferral, typically involving the services of a tax exchange professional. Discover things about Section 1031 tax-deferred exchanges that everyone engaged in real estate investing should know.

Investing in Rental Properties for Beginners - by James Kobzeff

Are you new to real estate investing, or about to become a real estate investor? Perhaps you are wondering, how does real estate investing work, or just want more investing real estate information because you want to sell rental

Newest Articles in Finance

How Day Trading Works - by Micheal James
Day trading can be defined as a trading methodology where investors are involved in buying and selling of stocks during the same day. This means that you are not holding the shares overnight, which you have brought, and you

Making Money with Forex Online Signals - by Matus Majersky
Forex trading is actually a lucrative business. Of course, you can only be successful if you know the ins and outs as well as the risks and benefits of trading in the Forex market. Investing in the foreign exchange

The IRC Section 1031 Tax Deferred Exchange - by Kimberly Tomlin Ladd
The tax deferred exchange provides property owners with one of the last true tax breaks and the only voluntary method for deferring capital gains tax on the sale of investment and business property. Unfortunately, many property owners don't capitalize on the benefits of IRC Section 1031.

Help for those on ChexSystems - by Mark Rude
You innocently walk into a bank or credit union to open up a new checking account and BAM you are introduced to the cold hard world of ChexSystems. You are told they can not open an account for you

Your Tax Dollars at Work - by Tony Robinson
In case we should ever stop to question the government and the tax dollars of the US citizens has on the economy, let's take a look at the influence the government exerts over our daily lives, and the impact