Tax Guru – Ker$tetter Letter

Q:

Subject: Recapture

Hello,

I happened upon your website and was interested in what you said about the recapture tax rates.  I wanted to know one more thing on that subject:

Using a rental property as the subject for discussion, is the recapture tax rate on the amount recaptured from depreciation still 25%?  Or do we use the Long Term Cap Gains rate of 15%?

Where is that written in the IRS Tax code?

Thanks for your time

A:

Depreciation recapture has been around for decades and is accepted as part of the tax benefit concept.  Basically, if depreciation expense has been allowed or allowable to reduce your ordinary income tax, its recapture should also be subject to ordinary income taxes.

With one basic exception, all depreciation recapture is reported on Form 4797 and is subject to ordinary income tax rates.  The one main exception is straight line depreciation on Section 1250 property, which includes most kinds of real estate, which has a special federal recapture rate of 25%.  If accelerated depreciation was used, the excess over what the straight line method would have been is taxed as ordinary income.

In the sale of a rental property, it is often the case that depreciation recapture on the structure (Sec. 1250 property) is taxed at the 25% rate, while depreciation on other separately identified assets, such as appliances and fixtures (Section 1245 property) are taxed at the normally higher ordinary income tax rates.

The special 15% long term capital gain tax rate only applies to any gain remaining after accounting for the depreciation recapture.

Your personal professional tax advisor can better assess how these rules will work in your case.

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,

Thanks so much for your useful info.  It was quite helpful to me.