Selling rental property, tax questions

[surprising]

Thinking of selling a rental property next year. Will net over $350K, so planning to restructure my investments to remove any dividend stocks etc to avoid any additional income. I will have some interest income from savings.
For taxes, I understand that I need to adjust cost basis to include depreciation recapture. Does this *only* include the depreciation part of my tax deductions that I claim on the rental property? Every year in addition to the depreciation, I also deduct prop taxes, maintenance, repairs, etc. I'm assuming none of this is part of depreciation recapture.

For taxes, I think the basic formulas are:
(adjusted cost basis) = (buy price) - (depreciation recapture) + (capital improvements)
Gain = (sale price) - (adjusted cost basis)
Tax = (depreciation recapture) * (ordinary tax rate) + ((gain) - (depreciation recapture)) * (long term cap gain rate)

Putting in some numbers:
(buy price) = 135000
(depreciation recapture) = 36000
(sale price) = 440000

(adjusted cost basis) = (135000) - (36000) + (0) = 99000
Gain = (440000 - 99000) = 341000
Tax = (36000) * (ordinary tax rate) + (305000 * LTCG rate of 15%)

Now, given that my 'ordinary income' is so low here, my ordinary tax rate will be 10% and my LTCG will actually be slightly less than 15% as a portion will be taxed at 0% LTCG rate ( 94050 - 36000 - (standard deduction)). Is that correct?

If I did the math correctly, it looks like I'll be paying about $40K in taxes for about $370K cash in hand (sale price - mortgage) = ~11% in taxes. Does it sound about right?

 

[cathy63]

I highly recommend spending some time with IRS Pub 523. The worksheets in there helped me through all the basis calculations when we sold a rental property last year.

Depreciation recapture is only for the part of your deductions that was actual depreciation, not the prop tax or any other expenses. It does include all the depreciation you "took or could have taken". Some people don't take it, thinking then they won't have to recapture it, and it doesn't work like that.

You also subtract selling expenses when calculating your gain; so anything you pay to a real estate agent, closing costs, etc, reduces the gain.

Your rough estimate on the tax is good, except that you can use the 2025 numbers that were announced last week for the standard deduction and brackets: 2025 Tax Brackets

For actually paying the tax, you can pay 100% (or 110% if 2024 AGI is over $150K) of your 2024 tax liability via withholding or 4 equal quarterly payments to reach a safe harbor then pay the actual balance due in April 2026. If you sell early enough in the year, you might be able to earn a nice bit of interest on the money you'll need to pay the taxes before you actually have to send it in.

 

[Koolau]

We used our CPA (and his past figures since he had handled all the tax w*rk while we were "landlords.") It didn't cost a fortune and I never worried that I had made a mistake. We didn't want the IRS questioning what we had done and not exactly how to answer them.

Best luck with the sale and the tax issues.

 

[SecondCor521]

"Tax = (36000) * (ordinary tax rate) + (305000 * LTCG rate of 15%)"

Using 10% ordinary rate, the above math works out to $49,350, but it doesn't account for, as you mention, a chunk of the capital gain being at 0%. It also ignores any other income you might have, and your standard deduction.

For anyone reading this thread later, depreciation recapture is at your ordinary income tax rate up to 25%. Doesn't make a difference in this case, but it could for someone in a different tax bracket.

ETA: Agree with cathy63 - real estate agent fees are often a significant amount and can help reduce the gain.

 

[Koolau]

Keep in mind that depreciation recapture can suddenly put you over limits for other things such as IRMAA. That happened to us when we sold our rental property.

Perhaps there's a way to sell on contract to cut yearly income??

 

[ut2sua]

Does this *only* include the depreciation part of my tax deductions that I claim on the rental property?

I believe total depreciation is part of the equation (whether you have taken the full depreciation benefit in your tax accounting or not). I will provide what I know, but I would recommend working with a CPA since this stuffs could be complicated.

Every year in addition to the depreciation, I also deduct prop taxes, maintenance, repairs, etc. I'm assuming none of this is part of depreciation recapture.

Only the depreciation will be taken into account. Taxes, maintenance, repairs are part of expenses, and you don't need to worry about recapturing taxes.

For taxes, I think the basic formulas are:
(adjusted cost basis) = (buy price) - (depreciation recapture) + (capital improvements)
Gain = (sale price) - (adjusted cost basis)

Your "depreciation recapture" in the above equations should be "depreciation"
Basically, the IRS gave you a tax break by allowing (or forcing) you to have the depreciation. When you sell the property, the IRS wants to recapture that "deferred" taxes using the depreciation recapture formula.
Again, the $ involved is large enough for you to talk to a CPA to make sure you won't pay too much taxes. If you have rented the property out for many years, expect a larger tax bill due to the depreciation recapture.

 

[SecondCor521]

Only the depreciation will be taken into account. Taxes, maintenance, repairs are part of expenses, and you don't need to worry about recapturing taxes.

Your "depreciation recapture" in the above equations should be "depreciation"

+1 on both.

 

[Texas Proud]

I did not look too far into it but FWIR it is only excess depreciation over straight line that need to be recaptured.... need to do some research...

TurboTax Tip:​

Section 1250 property placed in service after 1986 is likely to be depreciated using the straight-line method under the Modified Accelerated Cost Recovery System (MACRS). As a result, it’s rare to have gain from the sale of Section 1250 treated as ordinary income these days.

 

[pb4uski]

From my research, while the above is true, these days any depreciation recapture is typically treated as Unrecaptured Section 1250 Gain taxed at ordinary rates, subject to a maximum tax rate of 25%.

Whereas depreciation recapture on section 1245 capital property is taxed at your ordinary tax rate, depreciation recapture on real estate property, section 1250, is taxed at a different rate which is capped at 25%. Additionally, the part of the gain that goes beyond the original cost basis is taxed at the long-term capital gains tax rate.

Source: Depreciation Recapture In Real Estate: Definition, Calculation, and Examples – Landlord Studio

 

[surprising]

I did not look too far into it but FWIR it is only excess depreciation over straight line that need to be recaptured.... need to do some research...

Looking at my tax returns it looks like I didn't take straight line depreciation over the years (turbotax handled it all). Started out around $3300 10 years ago and last year it was $3000. Does this mean there are two separate tax rates? One for straight line and one for anything above straight line?

 

[Texas Proud]

Looked a bit deeper... I did not see the various tax rates yet but it says a maximum of 25%... so less than ordinary income if you make a lot...

Found this... makes a bit more sense to me...

A Guide to Depreciation Recapture for Real Estate

Explore the intricacies of tax depreciation and depreciation recapture as crucial considerations for real estate organizations planning to sell assets, including the complexities of IRS regulations, asset categorization, and potential tax implications.

www.eisneramper.com

In real estate property, as noted above, there are two kinds of depreciation recapture:

• Section 1250 recapture is the gain to the extent of the excess of depreciation claimed over straight-line and is taxed at ordinary income rates.
• Unrecaptured 1250 gain is the gain to the extent of straight-line depreciation taken and is taxed at a 25% maximum rate.
• Any additional gain is generally taxed at long-term capital gain rates (subject to certain Section 1231 ordinary loss recapture rules which are outside the scope of this article).

 

[Texas Proud]

In my reading many years ago I did not think any straight line depreciation was recaptured... that it was all cap gain... I used SL on my DW's condo when we married... guess I was wrong... but I did not look that deep into it so there is that...

I also thought that all accelerated depreciation was going to be recaptured at ordinary income... but it does look like only excess over SL... so if you own it long enough you do not have any recapture as ordinary income...

 

[cathy63]

Looking at my tax returns it looks like I didn't take straight line depreciation over the years (turbotax handled it all). Started out around $3300 10 years ago and last year it was $3000. Does this mean there are two separate tax rates? One for straight line and one for anything above straight line?

You are required to use straight-line depreciation for residential rental property. You didn't say in your OP that this is a residence that you're renting out, so I assumed that, and maybe it's actually a commercial property. Could you clarify what it is? Also, are you also depreciating any improvements you made using other recovery periods?

If the only thing you're depreciating is the original residence and you put it in service 10 years ago, then it's straight line depreciation. Year 1 should have a smaller depreciation expense and all subsequent years should have the same larger expense. This straight-line depreciation is recaptured and taxed as ordinary income but capped at 25%. Based on the numbers in your first post, you aren't anywhere near the 25% rate on this.

If you added depreciation for other improvements as you went along, then the depreciation amounts could vary from year to year, but I think year 1 should still be smaller than subsequent years, so it's somewhat concerning that it's greater.

Do you have all of the TTax depreciation worksheets for all 10 years? Looking at those should help you figure out what's going on.

 

[surprising]

You are required to use straight-line depreciation for residential rental property. You didn't say in your OP that this is a residence that you're renting out, so I assumed that, and maybe it's actually a commercial property. Could you clarify what it is? Also, are you also depreciating any improvements you made using other recovery periods?

If the only thing you're depreciating is the original residence and you put it in service 10 years ago, then it's straight line depreciation. Year 1 should have a smaller depreciation expense and all subsequent years should have the same larger expense. This straight-line depreciation is recaptured and taxed as ordinary income but capped at 25%. Based on the numbers in your first post, you aren't anywhere near the 25% rate on this.

If you added depreciation for other improvements as you went along, then the depreciation amounts could vary from year to year, but I think year 1 should still be smaller than subsequent years, so it's somewhat concerning that it's greater.

Do you have all of the TTax depreciation worksheets for all 10 years? Looking at those should help you figure out what's going on.

It is residential rental property. I just looked over the worksheets and yes the main depreciation for the rental was $3030 a year. There were other smaller depreciations to cover other assets that were in the property when we bought it (microwave, frig, w/d ..) that phased out in the first few years. Looks like also when we replaced the w/d we took a one time depreciation for that year. I am guessing I need to recapture all of these depreciations?

 

[Texas Proud]

No, not the appliances etc.... you are not selling them at a gain... it is ONLY the RE that you are selling...

Now, improvements on the RE you do...