(Greetings from the beaches of Belize. Thankfully, technology allows me to get you something useful and not have to be in front of my computer!)
My mother always taught me to speak properly and avoid foul language. I tried, but didn’t always live up to her faith in me.
As I’ve matured, my speech patterns have certainly mellowed.
Years ago, part of my real estate education was to be introduced to a four-letter word that had potentially nasty connotations. The word?
RECAPTURE.
It may not count out to four letters, but if it’s tax time, and you’ve sold depreciated property and not considered recapture, you will utter a few unsavory words yourself!
According to Investopedia, “Depreciation recapture is the gain realized by the sale of depreciable capital property that must be reported … for tax purposes. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus “recaptured” by reporting it as … income.”
In English, that means that if you’ve used the benefits of depreciation while you owned a property, you’re expected to pay taxes on that when you sell.
That can be quite a tax hit because the recapture tax is added to your capital gains tax. In some cases, this can bring your effective tax burden up close to 50% of your realized gain at sale.
Years ago, I had not been exposed to the term and didn’t understand the tax ramifications. I was a guarantor on a large loan, but there was a “burn-off”, meaning that after a certain time, my personal guarantee was no longer in effect.
Once I was no longer responsible for the debt, I could no longer take advantage of the depreciation. That triggered recapture of all the depreciation I had gladly accepted over the previous five years.
It was a large property with a large depreciation number. I quickly learned about recapture and scrambled to shelter as much as possible. It was early in my real estate career, and I was forced to pay taxes on a meaningful portion of my recapture.
It was painful.
So, my mission is to help you avoid mistakes by learning from mine.
Understand that, while depreciation IS a gift from the government, they will want their gift back when you sell.
There are ways to mitigate this tax burden and I’ll discuss that in a separate blog. As I have said before, tax savings put money directly into your pocket. There are solutions that can help you to avoid an onerous tax bill if you know your options.
For now, it will help to understand recapture, how it’s taxed, and how to roughly calculate it. As always, consult your CPA to get an accurate assessment.
I’ve put together a short video to give a broad understanding of recapture and how it’s calculated. If you want to avoid unexpected taxes, click the link below.
Click Here To Save on Your Tax Bill
Until next time!
Tom
