Selling Rental of 15 years and impact depreciation has on capital gains.

When you sell the property, you have to recapture the depreciation that you have taken (or should have taken) over the years.  You have to recapture it whether or not you take the deduction.  You are required to recapture the allowable depreciation, meaning the depreciation you could have claimed, not the amount you actually claimed a deduction for.  

Rental expenses are not depreciated.  You only depreciate the property itself and any capital improvements.  Capital improvements that add to the value of your rental property, prolong its life, or adapt it to new uses must be depreciated over a period of time rather than deducted as a current-year expense.  

What is rental depreciation and how does it differ from an expense?

Depreciation recapture can cause a significant tax impact if you sell a residential rental property. 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%.

Now here's some good news. Any passive activity losses that were not deductible in previous years now become fully deductible when a rental property is sold. This can help offset the tax bite of the depreciation recapture tax.

Tax Deductions for Rental Property Depreciation

As I'm sure you're aware, you are required by law to depreciate rental property. Many incorrectly believe that depreciation is a permanent deduction from their taxable income. it is not.

Depreciation is a reduction of your cost basis. You are required to depreciate any property that is used to produce income. However, land is not depreciable. Only the value of the structure is depreciated.

So if you paid $100,000 for a rental property 10 years ago, that first year renting it out you would have been required to provide a value for the land that rental property sits on, and a separate value for the structure itself. So for this scenario lets say the land was valued at $30K and the structure was valued at $70K. That means you would be required to depreciation the $70K value of the structure over 27.5 years. Therefore over ten years you would have taken approximately $2,541 each year for a total of $25,410 over 10 years.

So after 10 years you sell the property for $90,000. You would think that since you purhcased it for $100,000 that would be you sold at a loss. But not so fast. That $25,410 of depreciation is subtracted from your cost basis of $70K on the structure. So you subtract the $25,410 of depreciation you took from your original $100K you originally paid for it, and you have an adjusted cost basis of $74.590.

So if you sold the property for $90K that means you have a taxable gain of $15,410

Now the above is an extremely simplistic scenaro. In reality, you may have property improvements that will increase the cost basis (which are depreciated also) as well as deductible things related to sales expenses and the such.  For example, since rental property always operates at a loss on paper at tax time, in the year you sell you first deduct all your carry over losses from your taxable gain. So that reduces your taxable amount even more.