Definition
Recapture of depreciation, also known as depreciation recapture, is a tax provision under U.S. tax law that allows the Internal Revenue Service (IRS) to reclaim certain depreciation deductions previously taken by the taxpayer. When an asset, particularly real estate, is sold, the amount of depreciation taken over the asset’s life is “recaptured” and taxed as ordinary income, rather than at the lower capital gains tax rate.
Examples
- Rental Property Sale: If a rental property owner took $200,000 in depreciation over the course of 10 years and eventually sold the property at a gain, the IRS would recapture the $200,000, taxing it at the taxpayer’s ordinary income tax rate, while any additional gain might be taxed at the capital gains rate.
- Commercial Property Sale: A business owner sells a commercial building for $1 million after taking $300,000 in depreciation deductions. The $300,000 in depreciation would be subject to recapture and taxed as ordinary income, in addition to the gain amount potentially being subject to capital gains tax.
Frequently Asked Questions (FAQs)
What is the purpose of depreciation recapture?
Depreciation recapture is intended to reclaim the tax benefits that were initially granted to property owners through depreciation deductions, ensuring that the gains from the sale are taxed appropriately.
How is depreciation recapture calculated?
Depreciation recapture is calculated by taking the total amount of depreciation deductions previously claimed and taxing that amount as ordinary income at the taxpayer’s marginal tax rate, up to a maximum of 25% for real estate properties.
Does depreciation recapture apply to all property sales?
Depreciation recapture typically applies to properties that have been depreciated for tax purposes, including rental and business properties, but not personal residences.
Are there any exceptions to depreciation recapture rules?
Some exceptions may apply, such as 1031 exchanges and certain losses on the sale of properties where depreciation wasn’t across categories like Section 1250 property (real estate).
Related Terms
- Capital Gains Tax: A tax on the profit from the sale of property or an investment.
- 1031 Exchange: A tax deferral strategy that allows for the deferral of capital gains and depreciation recapture taxes when selling and reinvesting in similar properties.
- Depreciation: The process of allocating the cost of a tangible asset over its useful life.
Online Resources
- IRS Publication 544: Sales and Other Dispositions of Assets
- Investopedia: Depreciation Recapture
- National Association of Realtors
- IRS Website on Depreciation Recapture
References
- Internal Revenue Service. “IRS Publication 544: Sales and Other Dispositions of Assets”.
- Investopedia. “Depreciation Recapture”.
Suggested Books for Further Studies
- “Real Estate Taxation: A Practitioner’s Guide” by David F. Windish
- “Principles of Real Estate Practice” by Stephen Mettling, David Cusic, and Kirah Van Sickle
- “Tax Advantages of Owning Real Estate” by Bovel & Monahan
Real Estate Basics: Recapture of Depreciation Fundamentals Quiz
### What is recapture of depreciation?
- [ ] A process where appreciation is recalculated.
- [x] A tax provision that recovers depreciation deductions upon asset sale.
- [ ] A method of increasing the value of real estate.
- [ ] None of the above.
> **Explanation:** Recapture of depreciation is a tax provision used by the IRS to reclaim depreciation deductions when an asset is sold.
### Over which category of property does depreciation recapture primarily apply?
- [ ] Personal residences
- [x] Income-producing properties
- [ ] Vacant land
- [ ] Personal vehicles
> **Explanation:** Depreciation recapture primarily applies to income-producing properties that have been depreciated for tax purposes.
### What tax rate is applied to recaptured depreciation of real estate?
- [ ] Capital gains tax rate
- [ ] 15%
- [x] Up to 25%
- [ ] Social Security tax rate
> **Explanation:** For real estate, the recaptured depreciation is taxed at ordinary income tax rates, up to a maximum of 25%.
### Can depreciation recapture be deferred, and if so, by what method?
- [ ] Direct sale
- [ ] Deferment application
- [x] 1031 Exchange
- [ ] It cannot be deferred
> **Explanation:** Depreciation recapture can be deferred using a 1031 exchange, which allows for reinvesting the proceeds into similar properties.
### When does depreciation recapture occur?
- [x] Upon the sale of the asset
- [ ] Every tax year
- [ ] When claiming deductions
- [ ] During property appraisal
> **Explanation:** Depreciation recapture occurs when the asset is sold, at which point the IRS reclaims the depreciation deductions.
### Which section of the IRS code often deals with real estate depreciation recapture?
- [ ] Section 1031
- [ ] Section 162
- [x] Section 1250
- [ ] Section 401K
> **Explanation:** Section 1250 of the IRS code deals with the requirements and conduct of depreciation recapture on real estate properties.
### Is depreciation recaptured for properties sold at a loss?
- [ ] Yes, it always applies
- [x] No, not if sold at a loss
- [ ] Only if the market value is less than the book value
- [ ] No, it never applies to losses
> **Explanation:** Depreciation recapture does not apply to properties sold at a loss because there isn't a gain to reclaim the previous depreciation deductions from.
### Who is primarily responsible for calculating depreciation recapture?
- [ ] Real estate agent
- [ ] Local government
- [ ] Property appraiser
- [x] Property owner or their accountant
> **Explanation:** The property owner or their accountant is responsible for calculating the depreciation recapture when the asset is sold, ensuring proper tax reporting to the IRS.
### How does 1031 exchange affect depreciation recapture?
- [ ] It eliminates the need for it.
- [ ] It changes the recapture to yearly tax.
- [x] It defers depreciation recapture.
- [ ] It increases the amount recaptured.
> **Explanation:** A 1031 exchange defers the depreciation recapture to the new property, allowing sellers to reinvest without immediate tax liability.
### Is recapture of depreciation reported annually?
- [ ] Yes
- [ ] No, only upon lease agreement
- [x] No, only when the asset is sold
- [ ] Yes, but only for commercial properties
> **Explanation:** Recapture of depreciation is not reported annually; it is reported only when the depreciated asset is sold and the tax must be settled with the IRS.
