Do I have to recapture depreciation on appliances for rental property?
Sale of rental property - Do we include depreciation on appliances as well as the building? Yes, when you sell a Rental Property and its assets, you must allocate the sales proceeds to all assets that were sold. This includes appliances and improvements that have been depreciated.
Investors may avoid paying tax on depreciation recapture by turning a rental property into a primary residence or conducting a 1031 tax deferred exchange. When an investor passes away and rental property is inherited, the property basis is stepped-up and the heirs pay no tax on depreciation recapture or capital gains.
Internal Revenue Code Section 1250 states that depreciation must be recaptured if depreciation was allowed or allowable. So, even if you don't claim the annual depreciation expense on rental property that you're legally entitled to, you'll still have to pay tax on the gain due to depreciation when you decide to sell.
What Assets Are Subject to Depreciation Recapture? Depreciation recapture can apply to any depreciable assets for which you've received tax deductions in the past. The mechanism particularly applies to real estate investors who have made long-term capital gains on a rental property or investment property.
Generally, the IRS allows for property depreciation over a useful life of 27.5 years. But the IRS categorizes appliances as individual assets with different recovery periods from the building. For example, appliances have a useful life of 5 years for the purposes of depreciation.
When you sell a depreciated capital asset, you may be able to earn a “realized gain” if the asset's sale price is higher than its value after deduction expenses. You'll then be able to recapture the difference between the two figures after you report it as income.
Depreciation recapture is the portion of your gain attributable to the depreciation you took on your property during prior years of ownership, also known as accumulated depreciation. Depreciation recapture is generally taxed as ordinary income up to a maximum rate of 25%.
You should have claimed depreciation on your rental property since putting it on the rental market. If you did not, when you sell your rental home, the IRS requires that you recapture all allowable depreciation to be taxed (i.e. including the depreciation you did not deduct).
Don't be fooled – choosing to forego depreciation expense while you hold the property will not save you; the IRS will treat it as if you claimed it anyway. The only true way to get around depreciation recapture (other than selling at a loss) is to do a 1031 exchange and defer your taxes for as long as possible.
Real estate investors use the depreciation expense to reduce taxable net income during the time they own a rental property. When the property is sold, the total depreciation expense claimed is taxed as regular income up to a rate of 25%.
What is the depreciation recapture tax rate for 2022?
| Federal Income Tax Items | 2021 | 2022 |
|---|---|---|
| Federal tax rate on the portion of long-term gain from real estate that represents depreciation recapture (so-called “Section 1250 gain”) | 25% | 25% |
| Federal tax rate on long-term gain from collectibles (e.g., art, antiques, precious metals, gems, stamps, coins, etc.) | 28% | 28% |
Depreciation recapture is the gain realized by the sale of depreciable capital property that must be reported as ordinary income for tax purposes. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis.
How Long Do You Depreciate Appliances? Rental property appliances depreciate for 5 years.
Claiming the Deductions
To record the profit and loss from your rental business, fill out Schedule E of Form 1040. List repairs and maintenance expense for the year in line 14. If you purchased appliances or made improvements, you need to independently calculate depreciation for the year and enter it in line 18.
Normally appliances and carpeting are depreciated over 5 years. But, an investor could claim 100% bonus depreciation of $10,000 for the first tax year. The single-family rental home with a value of $110,000 would be depreciated over 27.5 years, for an annual depreciation expense of $4,000.
Depreciation recapture on real property is nothing more than a specially taxed type of capital gain. As such, it can be offset by capital losses. Real property used in a trade or business or held out for rental is subject to an allowance for depreciation.
Depreciation recapture is the portion of the gain attributable to the depreciation deductions previously allowed during the period the taxpayer owned the property. The depreciation recapture rate on this portion of the gain is 25%.
Depreciation recapture on real property is nothing more than a specially taxed type of capital gain. As such, it can be offset by capital losses. Real property used in a trade or business or held out for rental is subject to an allowance for depreciation.
Don't be fooled – choosing to forego depreciation expense while you hold the property will not save you; the IRS will treat it as if you claimed it anyway. The only true way to get around depreciation recapture (other than selling at a loss) is to do a 1031 exchange and defer your taxes for as long as possible.
After the entire cost basis has been deducted over 27.5 years, depreciation ends. Depreciation can also stop after the property is sold or the rental property has stopped producing income.
What happens to unused depreciation when you sell a rental property?
Depreciation Recapture Tax
Real estate investors use the depreciation expense to reduce taxable net income during the time they own a rental property. When the property is sold, the total depreciation expense claimed is taxed as regular income up to a rate of 25%.
