How depreciation affects the sale of the rental property in the future?

Question

Dear Folks,

I relocated to a new place due to change of my work. I converted my primary home to a rental property after this relocation. I am planning to do depreciation on the tax return for 2007. I am just not quite clear about the future effect that will be caused be depreciation? Will the depreciation be added when calculating the capital gain of selling the porperty? What if the property did not make money due to a depressing market?
Thanks a lot.

Thanks very much for the great answers. For Empire Realty, my question is that, under the 250k exclusion. if the gain plus depreciation is within 250k by the time I sell it. I will be liable to no tax. Is that right?

Answer 1

If the property depreciated, then there should be no capital gains tax - since the property is worth less than what you bought it for (unless you bought it prior to the beginning of the housing boom in 1995).

Answer 2

1) Don't convert your primary residence into a rental, you will loose your primary home appreciation deduction after 36 months and then you will be liable for capital gains on the appreciation you have accumulated while in it as your primary residence.
2) When you depreciate a rental you will be taxed at the recapture rate which is more than capital gains, if your holding period on the rental is short you may not want to accrue the depreciation so you don't have to pay the recapture rate.

Answer 3

Income tax depreciation taken is a 'fake expense' used to reduce your taxable income from the property. In other words, you don't actually PAY for depreciation, but you get to deduct it as an expense anyway. The downside is that, when you go to sell the property, the depreciation becomes part of the taxable gain on the property. So, yes, it is added back to the capital gains on the property.

Answer 4

I agree with acermill. You will have to "recapture" the depreciation when you sell. If if you don't take the deprecation, you will still have to recapture it. The IRS states that you must recapture depreciation that you took or could have taken. The good news is that homeowners can take a 250K exclusion (500K married filing joint) when selling a primary residence. If you lived in the house for 2 years out of the last 5 years, you might still be able to count it as your primary residence. So if you sell the house soon, you might be able to save some money. Or you can move back into the house for a couple of years before you sell.
For more info, see IRS 523 also 527
http://www.irs.gov/businesses/small/industries/article/0,,id=98921,00.html
http://www.irs.gov/taxtopics/tc414.html
http://www.irs.gov/pub/irs-pdf/p527.pdf
Take Care

Answer 5

Just to add to the previous correct answer, whether you take the depreciation deduction on Schedule E or not, the law requires you to reduce your basis by the depreciation allowed OR ALLOWABLE when you sell the property. So there is NO tax benefit under current law for not taking the depreciation deduction while the property is rented out. In fact, there is a significant penalty for not doing so.

Answer 6

what? I believe , if you rent property, you must claim depreciation, if you don`t you will still be liable for recapture tax....even if it is for 1 month..

what I don`t understand is you you pay 25% recapture tax on 100,000( amount of depreciation taken over x years) will the 100,000 also be a gain if the original cost basis was 300,000 and now you sell it for 300000 net ????