Past Articles

Depreciation
Depreciation, or cost recovery, is a tax deduction for the decline in value of a piece of property – based on wear and tear or estimated obsolescence. Depreciation is claimable even if the property has appreciated. The tax code determines the rate at which a property depreciates for tax purposes. For residential and non-residential real estate (excluding bare land) the portion of the cost attributable to improvements can be deducted in equal amounts over the scheduled period. Residential rentals can be depreciated over 27.5 years, while deductions for non-residential real property can be taken over 39 years. Personal property depreciation schedules vary depending on the type of property.

If you sell appreciated real property and you have taken deductions for depreciation, the portion of gain equal to the total amount of depreciation taken will be taxed at a 25% “depreciation recapture” rate. The remaining gain will be taxed at a 15% capital gains rate.   Additionally, the entire gain is usually subject to state income tax.  By exchanging property, these taxes are deferred. This year, the IRS issued simpler guidelines for depreciating the cost of replacement properties acquired in a 1031 exchange. We’ll explore these regulations in more detail in the next issue of the Summit Exchange.

Gain
In simple terms, gain is the amount of appreciation property has earned since it was purchased (plus the amount of any depreciation previously taken).  When a property is sold outright rather than being exchanged, the “recognized gain” is the taxable portion of the proceeds. In a previous Trade Talk column, we explained how to calculate basis. To calculate gain, subtract your basis from your exchange value – otherwise known as your net sales price (total sales price less closing costs and agent commissions). However, it is important NOT to assume recognized gain will equal the total cash received from the sale.   Generally these two amounts are unrelated.  Many times the gain on sale substantially exceeds the sale proceeds due to prior refinancings or cumulative depreciation deductions from prior years.