Possible Rental Gotcha for Retirees

[nwsteve]

Trying to do some planning around repositioning some of our rental portfolio and if I am correct, I may have tripped across a "Gotcha" coming from our planning to dispose of one(?) of our four properties.

Depending how the "income" from Depreciation Recapture is treated there actually could be two "Gotchas". One is the size of the tax bill, especially on one of our "older" (10 years) properties. The second one is the impact of the Depreciation Recapture income on reported income and negative impact on Medicare premium.
I was stunned to see how much the Part B premium bump up for the supposed "Higher Income" individuals. The first step is not too bad when you go over joint return of 170K (won't be hard to do when I have 117k of Depreciation Recapture). For 2017, extra premium over base is 53.50/mon/person plus another 13.30/mon for Plan D. If you break joint income of 214K, the Part B premium goes to 267.90/mon and Plan D extra is another 34.20/mon.

Can anyone advise me if there is any way short of a 1031 exchange to keep Depreciation Recapture out of MAGI that Medicare uses to set premiums?
The good news is that we have one move year before the RMD buzzsaw hits to absorb an income "bubble" from the depreciation recapture.

Thanks to all for any insight.

Nwsteve

 

[Sunset]

This is something that many retiree's have not really paid attention about. The depreciation which is great when working, is a building tax bomb. And it's worse in retirement for many folks.

Must take depreciation, so you save paying tax and maybe your tax rate is 15% when retired.
Then after some years you sell the property and have to recapture the depreciation at 25% !!!
The 25% is not because of the amount, but because it is recaptured, even if it was a single $1.00 it would be taxed at 25%.

The only way other than an exchange it is to sell the property really cheap, or die

 

[calmloki]

Yeah, the gal and I sold a little rental house in 2016 that we had for about 27 years. To make it extra special we sold with tiny down payment and are carrying the contract. In December we paid the federal and state tax on the sale. Seriously dipped into our pockets well past the down payment we received. Our tax person says she expects to have our taxes completed tomorrow and we will find out if we balanced our incomes enough to stay under one of the Medicare part D and prescription monthly cost steps. Seems like each step cost about $1000/year each.

Ya makes money, ya pays money.


Edit: BTW, we are carrying contract but paid tax as if we received the whole amount of the sale price. Should our buyers default we will get the place back and the IRS and state will assume we just got the property back with a new value: the amount of the sale price. Since we've already paid the taxes we get to start with a new depreciation amount, namely sale price! woohoo?

 

[Winemaker]

We are 10 years out for our 1st property to end depreciation expense. We are traveling the country now to determine where/when/if decide to do a 1031. We're pretty sure we are going to get screwed by somebody/something for being a provider of great housing at an affordable price. But ya try to stay away from where it's unfair, and go to where it's fair. Like Calmloki says, " Ya makes money, ya pays money." I'm just trying to find the best way, and do that.

 

[Hermit]

Don't wait until one of you dies. Then, as a single, you will really get nailed.

 

[meierlde]

Don't wait until one of you dies. Then, as a single, you will really get nailed.

Actually if I read this right filing status should not make much difference: Tax Matters: Tax Implications of “Depreciation Recapture” When Selling Real Estate in terms of tax due; recaptured depreciation is taxed at 25% and other gain at capital gains rates. Yes the medicare premium will likley be in a higher bracket in the big scheme of things likley not a major factor with real estate. (it terms of the cost of disposition, further if income falls the following year the additional medicare premium goes back down)

 

[Hermit]

Actually if I read this right filing status should not make much difference: Tax Matters: Tax Implications of “Depreciation Recapture” When Selling Real Estate in terms of tax due; recaptured depreciation is taxed at 25% and other gain at capital gains rates. Yes the medicare premium will likley be in a higher bracket in the big scheme of things likley not a major factor with real estate. (it terms of the cost of disposition, further if income falls the following year the additional medicare premium goes back down)

Yep, I was referring to the Medicare premium.

 

[Scrapr]

I sold a rental that we had for almost 10 years with 1031 rollover from about 5 years before. I don't know if the rental sale did this but we got kicked into the Alt Min tax

That was special

and if you do your math right you will notice the 2nd purchase was at the top of the market ouchie

 

[Fedup]

You only have to worry about recapture depreciation if you plan to sell. This is one of the many reasons my sister doesn't want to sell. Her property management company recommends she leaves it as is and when she dies her heirs will get a step up.

 

[Sunset]

I do recall reading on this site about a way to 1031 to some sort of stock fund type thing, where you are exchanging the property for a share of a collection of properties. The good point is it then becomes pretty hands off, delays taxes, and feels more like a fund.

However I'm vague on it, but searching may turn it up.

 

[clobber]

I sold a rental that we had for almost 10 years with 1031 rollover from about 5 years before. I don't know if the rental sale did this but we got kicked into the Alt Min tax

That was special

and if you do your math right you will notice the 2nd purchase was at the top of the market ouchie

+1

Because the full amount of your depreciation recapture is added to your MAGI, it can easily cause you AMT problems too. It did for me.

 

[almost there]

Plan to turn mine over to a mgt co. when I get too old to take care of it.
Then just leave to the kids.

 

[HawkeyeNFO]

Just paid my taxes today. Included a very painful depreciation recapture on a house we sold. No way around it: 25% or a 1031.

 

[DrBrisket]

Just paid my taxes today. Included a very painful depreciation recapture on a house we sold. No way around it: 25% or a 1031.

+1 on the binary choice.

+100000000 on the pain!

 

[Clone]

I see a lot of 1031 money coming into farm land that has been enrolled into CRP. Lock in a 10 to 15 year contract with the government at a fixed rate. Historically, the contracts can be rolled over and extended. If you are smart about it, and make sure the property is maintained every couple years, it is a very stable way to convert rental property or business property to an annuity.

 

[Luck_Club]

I knew this one guy that recaptured his properties by moving into each 1as his primary residence for two years before selling the properties. I guess that washes the depreciation recapture.??

 

[gerntz]

Can't wait. Oh well.

 

[Cobra9777]

I've been dreading this as well. We're planning to sell one of our rental houses this year. However, I plugged all our 2017 estimated numbers into TurboTax, including the estimated house numbers, and the result was not nearly as bad as I thought. I spent several hours studying the Schedule D tax worksheet, and recreating it in Excel, to make sure I understood the result.

First, it's not a flat 25%. It's a maximum 25% special CG rate, and only to the extent the gain falls into the 25% bracket or higher. It can also be taxed at 15% or 10% to the extent the gain falls into those brackets. Second, tax on the recapture appears to be considered first, before other qualified dividends and LTCGs. And last, we've only owned the house for 4 years, so while the gain is quite large for such a short period, the recapture itself is not.

In our case, we'll have to forego Roth conversions in 2017 to keep our ordinary income as low as possible. It also helped that we are "bunching" deductions this year. But then the recapture is taxed entirely at 15%. Our remaining QDs and CGs are partially taxed at 0% (below the top of 15% bracket) and partially at 15% (above the top of 15% bracket). This includes the portion of the house gain which is not recapture.

So even though our total taxable income is well above the top of the 15% bracket, the recapture itself still falls within the 15% bracket and is therefore taxed at 15% not 25%. Of course, the magnitude of the house gain pushed a portion of our other QDs and CGs into 15% territory, but the overall "hit" was not nearly as bad as I had been expecting.

Usually, when we bunch deductions every other year, it enables a larger Roth conversion. So the fact that we are foregoing conversions to get this result, probably means I just deferred the 25% hit until RMD time. I guess I can live with that. I'll also do some what-if's on still doing conversions as long as it doesn't push the recapture into 25% territory. My incremental tax on conversions will still just be 15% since it pushes 0% QDCGs into the 15% rate.

I also did some minor tweaking in the allocation of the sales price between the house itself (Sec 1250), personal property in the rental (Sec 1245... taxed as ordinary income) and land (no depreciation, thus no recapture). These tweaks did have some positive effect, but I didn't want to go too far with that.

 

[dtbach]

Another reason I'm glad I never went into real estate as an investment. Too complicated for me with more than it's share of "gotcha's"

 

[pjigar]

If you sell house as "owner financed" then the CG and recapture only happens on the payments actually received in a given year which will help you stay under the "tax bomb" ranges. If it is not too late then get paid monthly like a bank would get paid. Talk to you CPA but that's how I understand.

 

[ExFlyBoy5]

I knew this one guy that recaptured his properties by moving into each 1as his primary residence for two years before selling the properties. I guess that washes the depreciation recapture.??

We have given thought to this. We have owned our primary residence for 5 years and thought about selling it and then moving into the rental. Hang out for 2 years, then sell as the primary (and will also have owned it for 5 years) but it seems like there is a "gotcha" with this plan. BUT...we don't really intent to hand out in the ATL area much longer than we want to, so not sure if that's a great idea, either.

I am certainly not complaining, it's a good position to be in.

 

[pjigar]

I knew this one guy that recaptured his properties by moving into each 1as his primary residence for two years before selling the properties. I guess that washes the depreciation recapture.??

I think the law was changed recently so that you can't get all the gains tax free but rather only the prorated part for the duration you actually lived in the house.

 

[Sunset]

I've been dreading this as well. We're planning to sell one of our rental houses this year. However, I plugged all our 2017 estimated numbers into TurboTax, including the estimated house numbers, and the result was not nearly as bad as I thought. I spent several hours studying the Schedule D tax worksheet, and recreating it in Excel, to make sure I understood the result.

First, it's not a flat 25%. It's a maximum 25% special CG rate, and only to the extent the gain falls into the 25% bracket or higher. It can also be taxed at 15% or 10% to the extent the gain falls into those brackets. Second, tax on the recapture appears to be considered first, before other qualified dividends and LTCGs. And last, we've only owned the house for 4 years, so while the gain is quite large for such a short period, the recapture itself is not.

.......
So even though our total taxable income is well above the top of the 15% bracket, the recapture itself still falls within the 15% bracket and is therefore taxed at 15% not 25%. Of course, the magnitude of the house gain pushed a portion of our other QDs and CGs into 15% territory, but the overall "hit" was not nearly as bad as I had been expecting.

......

I hope you are correct, as I'm planning to sell a property in a few years and will have quite a gain and recapture, it would be nice if it costs less than I currently think.

Maybe they changed the rules since 2015 , but even this CPA website says the recapture is at 25% and the normal capital gain is at normal rates..

"However, not all gains benefit from the long term capital gain tax rates. Depreciation recapture is the portion of the gain attributable to the depreciation deductions previously allowed during the period the taxpayer owned the property. The deprecation recapture rate on this portion of the gain is 25%. The reasoning behind the depreciation recapture rules is since the taxpayer received the benefit of a depreciation deduction that offset ordinary income tax rates (a potential Federal tax savings of up to 39.6%), the government is not going to grant the most favorable capital gains rates on the portion of the gain relating to these prior depreciation deductions. The following examples illustrate the concept of depreciation recapture."


Tax Matters: Tax Implications of “Depreciation Recapture” When Selling Real Estate

 

[nwsteve]

If you sell house as "owner financed" then the CG and recapture only happens on the payments actually received in a given year which will help you stay under the "tax bomb" ranges. If it is not too late then get paid monthly like a bank would get paid. Talk to you CPA but that's how I understand.

Were it only true! Based on IRS Pub 544, Chap 3, all the depreciation recapture tax is due for the year of sale! It is true your remaining cap gains are prorated based on the installment sale schedule of payments.
Nwsteve

 

[pb4uski]

Were it only true! Based on IRS Pub 544, Chap 3, all the depreciation recapture tax is due for the year of sale! It is true your remaining cap gains are prorated based on the installment sale schedule of payments.
Nwsteve

+1