depreciation recapture

Example

“After claiming $50,000 in depreciation on the rental property, selling it triggered depreciation recapture tax on that $50,000.”

Memory Tip

Depreciation RECAPTURE = the IRS RECAPTURES the tax you saved through depreciation when you sell.

Why It Matters

Depreciation recapture directly affects how much you owe in taxes when you sell an investment property, rental property, or business asset. Understanding this concept helps you plan for the actual tax bill you will face at sale, since the tax rate on recaptured depreciation is often higher than capital gains rates, which can significantly reduce your net proceeds from the sale.

Common Misconception

Many people believe that all gains from selling an asset are taxed at the same capital gains rate, but depreciation recapture taxes the portion of gain from previously claimed depreciation deductions at ordinary income tax rates, which can be 15 to 37 percent instead of the preferential long-term capital gains rates of up to 20 percent. This means your total tax bill at sale can be substantially higher than expected.

In Practice

Suppose you bought a rental property for 200,000 dollars and claimed 50,000 dollars in depreciation deductions over several years. If you sell the property for 260,000 dollars, your total gain is 60,000 dollars, but the IRS treats 50,000 dollars of that gain as depreciation recapture taxed at ordinary rates and only 10,000 dollars as regular capital gain. If your ordinary income tax rate is 32 percent and your capital gains rate is 15 percent, you owe 16,000 dollars in taxes on the depreciation portion plus 1,500 dollars on the capital gain portion, totaling 17,500 dollars in taxes rather than the 9,000 dollars you might have expected if all gains were taxed at 15 percent.

Etymology

DEPRECIATION (previously deducted value) + RECAPTURE (the IRS recaptures those deductions upon sale).

Common Misspellings

Related Terms

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See Also