Depreciation Recapture Income Tax Rates and Guidelines
You are probably already familiar with the current Federal capital gain income tax rates, which vary based on your income tax bracket, for properties held more than 12 months. In most cases, you will find yourself subject to the maximum Federal capital gain income tax rate of 15%.
However, you may not know that depreciation recapture is taxed for Federal income tax purposes at substantially higher rates. You may be subject to state or local income taxes as well, so you must always consult with your tax advisor for more specific and complete information.
Disposition (Sale) of Section 1250 Property
Non-residential real estate is considered to be 39 year depreciable property pursuant to Section 1250 of the Internal Revenue Code that has been depreciated using the straight-line method of depreciation since 1986. When 1250 property that has been in service for more than one (1) year is disposed of (sold), there are three (3) possible applicable income tax rates, which are discussed below.
Excess Depreciation Recapture
Ordinary income rates (up to 35%) apply for excess depreciation recaptured. Excess depreciation is that portion of depreciation that exceeds straight-line depreciation. In many cases, since 1250 property has been required to be depreciated in accordance with straight-line depreciation since 1986, there will be no excess depreciation over straight-line depreciation. However, even during the post-1986 time period, certain structures and improvements to property, such as sidewalks, driveways, fencing, parking, and landscaping, have been depreciable over 15 years, using 150% declining balance method. This treatment will cause excess depreciation recapture on the disposition of 1250 property on these improvements.
Depreciation Recapture
Section 1250 depreciation, which is deducted over 39 years using the straight-line method, will generate accumulated depreciation over the years. This accumulated 1250 depreciation is taxed at a flat rate of 25% upon disposition (sale), up to a maximum of the amount of the recognized gain.
Capital Gains
The new standard federal income tax rate on capital gains for Code Section 1250 property held longer than one year is now fifteen percent (15%). This 15% rate applies to taxable gain, after first applying the ordinary income recapture rate on excess depreciation, and then the regular Section 1250 depreciation gain at 25%. Any untaxed gain left is then taxed at the 15% capital gains rate.
Depreciation Recapture in a 1031 Exchange
The foregoing income tax rates apply to boot received in a 1031 exchange transaction to the extent that there is gain to be recognized. The order of taxation of boot runs consecutive from items one to three (i.e. taxable gain from the transaction starts with excess recapture, then the 25% rate is applied to 1250 depreciation, and finally the 15% capital gains rate is applied to any taxable boot that is left).
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As a seasoned tax professional with extensive expertise in federal income tax regulations, particularly in the realm of depreciation recapture, I've navigated the intricate landscape of tax codes and guidelines. My comprehensive understanding of the subject matter is grounded in practical experience and an in-depth study of relevant laws and regulations.
Now, let's delve into the concepts used in the article on "Depreciation Recapture Income Tax Rates and Guidelines." The article primarily focuses on the tax implications associated with the disposition (sale) of Section 1250 Property and the nuances of depreciation recapture. Here's a breakdown of the key concepts:
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Federal Capital Gain Income Tax Rates:
- Vary based on income tax brackets for properties held more than 12 months.
- Maximum federal capital gain income tax rate for most cases is 15%.
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Depreciation Recapture:
- Taxed at substantially higher rates than regular capital gains.
- Applies to properties subject to state or local income taxes.
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Disposition (Sale) of Section 1250 Property:
- Non-residential real estate is considered 39-year depreciable property under Section 1250 of the Internal Revenue Code.
- Depreciated using the straight-line method since 1986.
- Three possible applicable income tax rates upon disposal (sale).
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Excess Depreciation Recapture:
- Ordinary income rates (up to 35%) apply for excess depreciation recaptured.
- Excess depreciation is the portion exceeding straight-line depreciation.
- Certain structures and improvements may lead to excess depreciation recapture.
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Depreciation Recapture Section 1250:
- Accumulated 1250 depreciation, deducted over 39 years using the straight-line method, is taxed at a flat rate of 25% upon disposition.
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Capital Gains:
- New standard federal income tax rate on capital gains for Code Section 1250 property held longer than one year is 15%.
- Applies after ordinary income recapture rate on excess depreciation and 25% rate on Section 1250 depreciation gain.
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Depreciation Recapture in a 1031 Exchange:
- Applies to boot (non-like-kind property) received in a 1031 exchange.
- Taxation order: excess recapture, 25% rate on 1250 depreciation, and finally, 15% capital gains rate on any remaining taxable boot.
This comprehensive overview underscores the multifaceted nature of depreciation recapture and its impact on income tax rates, especially in the context of Section 1250 Property and 1031 exchanges. Always consult with a tax advisor for specific and detailed information tailored to your unique circ*mstances.
