OK,
@pinkjelly1234 Part 1 on depreciation.
Depreciation is a deduction you can take for the "used up" value of a capital asset (usually, tangible property with an expected life more than one year). Let's start with a baker who buys an oven for $5000. That's not deductible all at once, but since the oven loses value over time as it becomes used. That's depreciation. In this case, the baker can take a depreciation expense over 5 years, or $1000 per year.
Now, you also need to know about cost basis. The cost basis of an item is the amount of already-taxed money you spend to acquire it. The cost basis of the oven is $5000 because the baker used after tax money to buy it. But each year that he takes a $1000 depreciation deduction, he is reducing his cost basis because some of the purchase was now made with tax-free money.
Whenever you sell something for more than your basis, you owe gains tax. If you buy a baseball card for $1 and sell it for $100, you pay tax on $99 because you already paid tax on $1. For the baker, since he has been taking tax deductions for depreciation, he has to pay tax if he sells the oven for more than his basis at the time of the sale. In year 4, the baker has deducted $4000 of depreciation, and the cost basis of the oven is $1000. If he sells it to a competitor for $1500, he owes tax on the $500, that is "recaptured depreciation."
With a house, land doesn't get used up, but the structure does. Let's say that for your house purchased for 249K, that 49K was the value of the land and the house was 200K. (You may not know the exact number but your tax accountant should, or you need a new tax accountant.) Houses depreciate over 27-1/2 years. So for each year that you rented it, you can deduct $7272 as a depreciation expense. You pay tax on your net rental income, so if you rented it for $2000 per month, you take the gross income, subtract expenses like insurance, taxes and maintenance and the property manager fee, also deduct depreciation, then pay tax on the net income. The depreciation reduces your taxable rental income. Since it's like taking tax-free money out of the house, it reduces your cost basis. After three years of rental, your cost basis is $249,000 minus (3 x $7272) = $227,184. If you sell for more than the cost basis, you have to pay tax on the gain that is due to depreciation. So whatever happens to the rest of the gains, the first $21,816 is depreciation recapture taxed at 25%.
This has to be paid if you were entitled to deduct depreciation, even if you did not actually deduct it. If your tax accountant did not deduct depreciation, you may need a new accountant (who can also fix the error and get you some of the benefit of the depreciation if you missed it before). Taking depreciation on rental property is always going to be a deduction when you rent that has to be paid back when you sell, but that's the way it works.
Hope the helps. Part 2 on what happens to the rest of the gain is coming soon.
