EZ Question On Capital Gains
3-unit Rental:
$100,000 - purchase price
$140,000 - sale price (probable)
$15,000 - depreciation taken
10% - my tax bracket
Please ignore the associated purchase/selling/improvement costs for the sake of clarity.
If I sell the 3-unit rental, is the gains tax total =
(5% x 25,000) + (25% x 15,000)
OR
(5% x 40,000) + (25% x 15,000)
(The 25% represents depreciation and 5% is the Cap gain rate for my 10% bracket)
Also, EVERYTHING I read on this says that the depreciation is taxed at the highest level of 25% but it's never mentioned what the other rates would be.
I do not know what my tax liability would be! Any help would be wildly appreciated!
(25% x 15,000) + (5% x 40,000)
Allowed depreciation is recaptured first, then the balance of your profit is taxed at the capital gains rate applicable to your tax bracket. All the depreciation that was allowed during your holding period is recaptured even it you actually took less.
There is only one rate for depreciation recapture regardless of your marginal tax bracket.
What a scam!!!
Am I understanding this?
You mean the IRS taxes me 25% on the 15,000 depreciation? (there's no way I got 25% of that $15,000 deduction)
In fact, lets say my income was less than $5,000 each year. Well, after the standard and itemized deductions, I would have $0 taxable income. Then I'd deduct depreciation and get NO reduction in taxes. But they're taxing me 25% of it when I got nowhere near that in the deduction!!? So I got $0 for the depreciation but now I must pay 25% of it (equalling $3750)?
Is that correct?
DaveT, referring to what you mentioned above ...if I NEVER deduct depreciation to avoid the recapture, do they nail you anyway on it even though you never took it?
Thanks again for the valuable responses.
You can opt out of taking the depreciation. You are given that choice. I don't know a whole lot about it. Maybe look at the www.irs.gov site. Of course if you never take the depreciation deduction in the first place there is no recapture.
I hope you could omit depreciation recapture if you never deducted it in the first place but DaveT said (above):
"All the depreciation that was allowed during your holding period is recaptured even it you actually took less."
So I wonder which is the case?
Thanks!
Well, I may be wrong. I thought that I remembered reading or hearing something about it in one of the courses or books I've read somewhere but I can't find it now. I can't find anything on www.IRS.gov either. Perhaps someone else has more expertise in this area and can enlighten both of us.
I am still not *totally* sure, but I found the following on www.irs.gov:
"Generally, the amount of depreciation you must recapture for residential rental or nonresidential real property is the excess of the depreciation allowed or allowable over straight line depreciation for the property."
I also looked at form 4797 and it uses the same terminology.
But the sentence starts with the word "generally" which allows the possiblilty of it NOT being the case.
So I don't know. It looks like it's true. I may call the IRS and ask.
What a complete ripoff it would be if it is true.
Consider this: If you buy a property and sell it a year later for a loss and you also had no income (or < $4000), YOU LOST MONEY ON IT, YOU DEDUCTED NOTHING FROM IT AND YOU MUST PAY THE IRS 25% (of depreciation) IN TAXES!!!
How unfair is that? Paying taxes on REAL losses.
Tony,
Perhaps this article from the TCI Archives will give you a little insight.
How Depreciation Is Recaptured
Instead of complaining about finally having to pay back a fraction of the depreciation you took that never materialized, you should adopt an attitude along the lines of "I can't wait until the day when my income tax bill is $1 million". Think about it. For your tax bill to be $1,000,000, your gross income will have to be in the $5 million range.
DaveT,
I did read that article in the past and the IRS is still demanding money not only if I never made a cent but even when I lose money.
Would you want to be taxed 1 million if you lost money overall?
My point isn't that I don't want to pay tax on the money I made, as you say, however it is that I am beling taxed without making a cent. Do you realize I could owe tax while never earning a cent?
Example:
Purchase price = 100,000
Sale price = 100,000
Depreciation = 4,000
Income = $0 (Assume I was injured or claimed by someone)
Now, with $0 Income, deducting depreciation didn't lower my taxes (because I had NO tax, or income), but I now mysteriously owe $1000 in tax (25% x 4,000 depreciation never taken)?
How deplorable!! How can I owe tax on no income whatsoever!!!
This is why depreciation should be OPTIONAL and if you didn't deduct it, you shouldn't be forced to recapture it ...like in the example above.
Tony,
While your example is a bit unrealistic, let's work with it anyway.
Assume for the moment that you never had any income from the property but that the property was in service for a qualified investment use for which depreciation is allowed. At the end of the tax year, you are allowed a depreciation expense of $4000. This gives you a net passive loss of $4000 for the property.
Because you don't have any income to offset you suspend the loss and carry it forward to the next tax year. Your book value for the property is now $96K ($100K minus $4K depreciation allowed). You decide to sell the property for your original purchase price which would seem to give you a capital gain of $4K ($100K sale price minus bood value), all attributed to depreciation.
Because you have a suspended passive loss of $4K, you get to reduce your capital gain by that amount. In effect, your basis is increased by your suspended passive losses, so, when the dust settles, your book value is once again $100K. With a sale price of $100K, your capital gain is really zero. Since none of your gain is attributed to depreciation, there is nothing to recapture.
I agree that there is a certain amount of inequity in fixing the depreciation recapture rate at 25%, when you might have only been in the 15% bracket the whole time. It would seem that you are paying an extra 10% in depreciation recapture that you never derived any benefit from in the 15% bracket.
I suppose the lawmakers would counter with the argument that your tax break is really on the larger portion of your profit when the capital gains tax rate was lowered to 5% for the 15% tax bracket. If you really want Congress to be fair about everything, I suppose you could lobby them to increase the 5% capital gains rate to 10% and lower the depreciation recapture rate to 15%. That way the depreciation would be recaptured at the same rate at which your ordinary income was taxed.
DaveT, Thank you for your response.
It looks as though, in my example, the recapture would be 0, not 4000. Thanks for pointing that out.
You did touch on my point, that is, that I am being taxed at 25% on something that gave me nowhere near 25%.
I am a unique case where I will probably never have a gross income more than $6000. The depreciation I deduct will NEVER give me a 25% return on it however, the IRS takes 25% back when recapturing it.
You're right, it would be better to tax recaptured depreciation at 15% instead, but even BETTER would be to allow depreciation to be optionally taken. That would seem to solve the problem and it would be fair to everyone. We would just have to keep track of how much we depreciated over the years.
Also, I note that you do mention in several other posts that the cap gain will be 0% in 2008 for those of us in the 10% tax bracket. HOWEVER, do not forget that if a Democrat is elected this year (OR in 2008 as well), all Democratic nominees are on record promising to cancel Bush's Tax relief ("roll back" is the term they use). So I am planning on seeing Bush re-elected, but after that, 2008 is a big gamble. Any thoughts on this?
Since the 10% tax bracket seems to apply to the single taxpayer with a taxable income under $7000 and to the married filing jointly taxpayer with taxable income under $14000, I don't quite see how the Democrats can justify including this group in the 'wealthy' class when rolling back the tax cuts for the wealthy.
Furthermore, since these reduced capital gains tax rates expire at the end of 2008 and return to their former levels in 2009, the Congress will see the end of this particular rollback without doing anything.