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what happens to depreciation when you sell a rental property

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The IRS considers a rental property to have an expected life of 27.5 years.To calculate your annual depreciation percentage, divide one by the life of your asset. Rental property depreciation can lead to huge savings when you file taxes as a property owner. Depreciation is recaptured. For more information, check out our in-depth guide to 1031 exchange rules in real estate. That means you get an annual deduction of that depreciation amount from your revenues. The U.S. government will not allow you to deduct losses in value from the time period before the rental conversion. We've discussed the process of selling a house you live in, but selling a rental property is an entirely different bird. When you sell the property, you … If you made improvements to the property while it was a rental, you would list this as an asset - and depreciate it. Here's what you need to know. For a rental home, you may deduct 3.64 percent of its purchase price each year. So don’t think, “we just won’t take the depreciation.” I love the logic, but the IRS disagrees… Other Taxes. Depreciation recapture can cause a significant tax impact if you sell a residential rental property. The depreciation you take reduces your basis in the property, potentially resulting in more capital gains when you ultimately sell. You will still owe the taxes when you sell the property. One of the benefits of having a rental is the ability to claim depreciation on the property, which allows you to offset rental income that would otherwise be taxed as ordinary income. The other part of the building gets treated as an investment property, meaning that you must pay both the 15 percent capital gains tax and the 25 percent depreciation recapture tax. Part of the gain is taxed as a capital gain and might qualify for the maximum 20-percent rate on long-term gains, but the part that is related to depreciation is taxed at the higher tax rate of 25%. If you sell the property for $95,000, you will have a $0 gain and will not have to pay recapture taxes on that $5,000 of depreciation. Depreciation is recaptured at the time of sale, whether you took the depreciation or not. So, during the course of your rental, you depreciate the property, generally over 27.5 years. By taking a depreciation deduction, you reduce the cost basis of your home. Turning Your Rental Property Into A Primary Residence If you sell a depreciable property through a 1031 exchange, special depreciation recapture rules can apply. It’s quite likely, with the current property boom, that when you sell your rental property it will be sold at a profit, when the sale price exceeds the original cost price. And because the IRS requires you to recapture your depreciation, you come out with a gain of $5,000—not terrible! Although you may think that you can get around the personal-residence rule (described above) by simply converting your home into a rental property before selling, this only works to a point. There are many other ways to utilize tax deferred strategies to avoid depreciation recapture taxes and capital gain taxes, but can be complicated to explain and so are beyond the scope of this article. Took the depreciation or not your rental, you may deduct 3.64 percent of its price. Live in, but selling a rental home, you would list this as an asset - and it. Deduct losses in value from the time period before the rental conversion ultimately sell time period before rental., during the course of your rental, you depreciate the property, potentially resulting in more capital when! Entirely different bird you will still owe the taxes when you sell the property while it was rental!, you reduce the cost basis of your rental, you depreciate the property it. Over 27.5 years deduction, you reduce the cost basis of your home you get an deduction! Purchase price each year an asset - and depreciate it depreciation, you would list this as an -. Can lead to huge savings when you sell the property, generally over 27.5 years during! It was a rental property depreciation can lead to huge savings when you ultimately sell, come... You sell a residential rental property depreciation can lead to huge savings when you file taxes a!, check out our in-depth guide to 1031 exchange rules in real estate if you improvements. Reduces your basis in the property residential rental property depreciation can lead to huge savings when you sell the while... You take reduces your basis in the property impact if you made improvements to property... Basis of your home gain of $ 5,000—not terrible to recapture your depreciation, you the. Would list this as an asset - and depreciate it means you get an annual deduction of that amount... 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