R is for Recapture

 

When you claim depreciation you get an ordinary tax deduction. Later when you sell or dispose of the asset, the gain is calculated based on the basis after depreciation. Essentially you get an ordinary tax deduction to decrease the basis, then when you sell, that gain is taxed as a capital gain which is a lower tax rate. To even things out and account for this difference, enter depreciation recapture.

 

The depreciation recapture is the amount of gain that is due to prior year depreciation. For real estate, that depreciation recapture is taxed at 25% instead of the normal capital gains rates. That 10% increase in the tax rate can be important when planning for the sale of real estate.

 

One sore spot with me is the first time homebuyer credit. The very first edition of the credit was $7,500, but it included a recapture provision that the credit needs to be paid back over 15 years. At the time, I was pleased to get the credit but subsequent editions eliminated the recapture provision which made the credit much more lucrative. That recapture tax is $500 per year unless the property is sold or transferred to non-personal use, in which case the remaining amount is all recaptured in one year. A lot of people didn’t understand how that worked and when they sold their house three years later, they got stuck with a big tax bill they didn’t see coming.

 

Taxes A to Z—still randomly meandering through tax topics, but at least for 26 posts in an alphabetical order.