@_Mix_ wrote:
we would only need to recapture $40K (not $100K) when the property is sold.
You have the general idea right. The MOST amount of the depreciation that would be taxed in the scenario is $40,000 (but it could be less). That is taxed at your ordinary tax rate. However, if these are short-term rentals, it is depreciated over 39 years, not 27.5 years.
In your original scenario, you would also pay tax on the $125,000 of profit (in addition to the $40,000 of gain due to depreciation). That would be taxed at long-term capital gains rates, which is usually 15% but could be 0% or 20%.
However, that 'extra' $165,000 of income when it is sold ($125,000 profit plus $40,000 due to the depreciation) could affect other things on your tax return. It could be subject to the 3.8% Net Investment Income Tax. Or it could reduce (or eliminate) some types of deductions or credits.
As Tagteam mentioned, after you factor in depreciation, real estate tax, insurance, mortgage interest, repairs, utilities, etc., most likely your annual profit for the rental will be fairly low, or possibly even a loss (whether or not a loss would be deductible gets much more complex).
