Depreciation Recapture Tax Rate in Real Estate
Overview: Depreciation Recapture Tax Rate in Real Estate
Depreciation recapture tax refers to the tax on the portion of the gain realized from the sale of a property that is attributable to the depreciation deductions claimed during the ownership period. When you sell an investment property, the IRS requires you to "recapture" the depreciation deductions you took over the years and pay tax on them.
Here’s how it works:
- Depreciation: When you own investment property, you can deduct depreciation from your taxable income each year, which reduces your tax liability. The IRS assumes that the property’s value declines over time (even if it doesn't in reality).
- Recapture: When you sell the property for more than its adjusted basis (original purchase price minus accumulated depreciation), the IRS requires you to pay tax on the depreciation deductions you took. This is known as depreciation recapture.
- Tax Rate: The depreciation recapture tax rate for real estate is capped at 25%. This means that any portion of your capital gains that is due to depreciation is taxed at a maximum rate of 25%, rather than the lower long-term capital gains tax rate (which could be 0%, 15%, or 20%, depending on your income).
For example, if you bought a property for $300,000, claimed $50,000 in depreciation over the years, and then sold the property for $400,000, you’d need to pay the depreciation recapture tax on the $50,000 in depreciation.
Summary of Tax Components:
- Depreciation Recapture Tax: Up to 25% on the portion of the gain attributable to depreciation.
- Capital Gains Tax: 0%, 15%, or 20%, depending on your income, for the remainder of the gain.
This tax only applies to investment or rental properties, not primary residences, which have different tax treatment under the IRS code.
