Understanding Depreciation Recapture in CRE

Depreciation of investment properties is the key to tax savings. When an asset like rental property generates cash flow, you can enjoy a steady income and build equity while your investments appreciate over time! Before we dig into rental property depreciation, it is imperative to know what depreciation recapture in CRE is.

What is depreciation recapture in CRE?

The gain earned on the sale of depreciable capital property that must be declared as ordinary income for tax purposes is known as depreciation recapture. When the sale price of an asset exceeds the tax basis or adjusted cost basis, depreciation recapture is applied. By reporting the amount as regular income, the difference between these figures is “recaptured.”

Expenses For Rental Property Tax Deductions

You use Form 4797 when reporting to the IRS your depreciation recapture, they also have a list of allowed expenses for tax deductions:

1. Repair and maintenance
2. Property taxes
3. Mortgage insurance
4. Operational expenses

Rental Properties You Can Depreciate

The IRS does not allow you to depreciate rental property, because it is impossible for this type of asset to wear down or become obsolete. You cannot take into account the cost of clearing land or landscaping when calculating how much has been put towards these amenities if they are included as part of your purchase price instead.

But here are the provisions from the IRS with regard to depreciation.

• It is anticipated that the property will last at least a year.
• You use the property for your business or other sources of revenue.
• You own the property.
• The property’s useful life can be predicted. It must be something that wears out, decays, is used up, becomes obsolete, or loses value due to natural reasons. This test is passed by rental properties.

Depreciating the cost of the building means you must allocate costs because you depreciate the building but not the land. To figure out the individual costs, look at your property tax bill and divide the land value by the building value.

When can you start depreciating and how much can you depreciate per year?

As per IRS, the moment your property is opened for business it can be depreciated for tax purposes. Rental properties are depreciated using the Modified Accelerated Cost Recovery System (MACRS). The MACRS method will spread the depreciation deductions over the property’s “useful” life of 27.5 years. In essence, your CRE property depreciates 3.636 percent annually.

Final Thoughts

You may be able to minimize your tax liabilities that result from recapturing depreciation or even defer paying any tax by conducting a tax-deferred exchange. To make a sound decision, a smart investment, and ensure a bright future ahead of you, contact a trusted decision partner who will help set up investments that work best for you.