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Investors & landlords
Understand that your gain/profit on the sale is taxed at the Capital Gains tax rate, while the recaptured depreciation is taxed as ordinary income. For simplicity, I’m not going to break out the separation of the gain and recaptured depreciation, and I’m not including sales expenses either.
House purchased for $100,000 and placed in service on Jan 1, 2010. Allocated $20K to the land and $80K to the structure. The land is not depreciated. Only the $80K on the structure gets depreciated over 27.5 years. Entered into TurboTax and classified as Residential Rental Real Estate. Entered as:
Date in Service: 1/1/2010
COST: $100,000
COST OF LAND: $20,000
The program (not you) does the math and depreciates the structure value of $80K over the next 27.5 years.
Had the roof re-shingled and was placed in service on Jan 1, 2013. At a cost of $10,000. Entered into Turbotax as:
Date in Service: 1/1/2013
COST: $10,000
COST OF LAND: $0
To figure the depreciation I use the worksheet the starts on page 38 and continues to page 39 of IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf. Table A-6 on page 73 applies here.
First year (2010) depreciation is $2788.00
2nd year (2011) depreciation is $2909.00
3rd year (2012) depreciation is $2909.00
For the 4th year, the new roof has added $10K to the cost basis of the depreciated assets. So the program “has” to figure depreciation on the roof separately since it was “NOT” placed in service at the same time the structure was.
4th year (2013) depreciation on the structure is $2909.00
1st year (2013) depreciation on the roof is $349
Total depreciation for 2013 is $3258
5th year (2014) depreciation on the structure is $2909.00
2nd year (2014) depreciation on the roof is $364
Total depreciation for 2014 is $3273
Depreciation each year on each asset will remain unchanged through 2021. Now let’s say we sold this property on Dec 31, 2021 for $200,000
Total depreciation on structure taken is $34,787
Total depreciation on roof taken is $3261
Total depreciation taken on all assets is $38,048
Let’s enter this in TurboTax the wrong way first.The “Adjusted Basis” is dealt with internally in the program as depreciation recapture. You don’t see this. I’m showing it this way for simplicity.
Cost Basis Depreciation Adjusted basis Sale Price Taxable Gain or (Loss)
Land $20,000 $0 $20,000 $40,.000 $20,000
Structure $80,000 $34,787 $45,213 $160,000 $114,787
Roof $10,000 $3261 $6739 $0 (-6739)
TOTAL $110,000 $38,048 $71,951 $200,000 $128,048
With the above you can see that the roof was reported as sold for zero dollars, indicating a loss on the sale of that one asset. So, the $3261 of depreciation is “NOT” recaptured and taxed as ordinary income, when it should be. Additionally, the remaining $6739 to be depreciated (if you didn’t sell the property) is also incorrectly reported as a loss.
Now let’s do it the right way.
Cost Basis Depreciation Adjusted basis Sale Price Taxable Gain or (Loss)
Land $20,000 $0 $20,000 $40,.000 $20,000
Structure $80,000 $34,787 $45,213 $130,000 $84,787
Roof $10,000 $3261 $6739 $30,000 $23,261
TOTAL $110,000 $38,048 $71,951 $200,000 $128,048
Now notice that your total taxable gain is the same in both scenarios above. However, in the first scenario the $3261 of depreciation on the roof is included in the profit on the structure and gets taxed at the higher Capital Gains tax rate.
But in the 2nd scenario, where you show a gain on all assets, the $3261 of depreciation on the roof is correctly recaptured and taxed at the lower “ordinary income” tax rate.
