Real estate investor software solutions

You sold an income property you owned for more than one year and planned only to pay a capital gains tax. With your proceeds you decided to splurge. You had no idea about the "depreciation recapture tax" you must also pay.

This was suggested to me recently by an real estate investor who never saw the recapture tax coming. Only to discover it later when his federal tax obligation computed higher than anticipated, and his proceeds computed lower. This is not a good thing. So it seems appropriate to mention it as a bit of income property advice to the new realestate investor.

Depreciation "recapture tax" (like capital gains tax) occurs when depreciable real estate is sold after one year of ownership. Property sold one year or less is classified as a "short-term" gain and gets taxed as ordinary income, so neither tax apply unless a property is held for more than one year.

Here's how it works.

When you sell an income property and have a recognized gain the feds want to tax you for the capital gain plus they want to tax you for the accumulated depreciation you've taken during the years you owned the property. Because the current capital gains tax rate is 15% and the recapture tax rate is 25%, you wind up paying more tax (thus, get to keep less) at the sale of your property than you would have by having to pay just the capital gains tax alone.

For example, if you realize a gain of $300,000 of which $100,000 is attributable to depreciation, your taxes might compute this way:

1. Your accumulated depreciation of $100,000 gets taxed at 25%. You owe $25,000 recapture tax.
2. The $200,000 remainder gets taxed at 15% (or the current capital gains tax rate). You owe $30,000 capital gains tax.
3. Your total tax obligation is $55,000.

Okay, now let's pretend that you had no knowledge of depreciation recapture tax.

In your mind, the full $300,000 gain would get taxed at 15% and therefore you expect to owe the IRS $45,000. Imagine the shock when you learn that you owe $55,000; a whopping $10,000 more tax than expected; hence, $10,000 less proceeds than expected. (Say goodbye to the wide-screen television).

Here's the bottom line.

Real estate investing requires sound real estate investment tax strategies. You should always consult a tax specialist before you sell rental income property. Good planning will keep you from getting blindsided at tax time and may prevent you from having to face an unpleasant surprise later.

So You Know

ProAPOD® provides affordable income property analysis software solutions with calculations for depreciation recapture tax. Learn more at www.proapod.com.

Feel free to share this article.