Still confused. When I purchased the furnaces I could have taken the entire cost as an expense in the year purchased OR I could depreciate it.. right?
Unfortunately, no. Your understanding is wrong. In order to deduct the cost of an asset as an expense under the Safe Harbor di-Minimus act, the first requirement is that it's cost must be less than $2,500. Earlier you stated the new furnace cost $10,900. So expensing it was not an option. Therefore, the other requirements to qualify for the safe harbor deduction are a moot point.
You also incorrectly classified it under MACRS as an appliance. A new furnace becomes "a physical and permanent part of" the structure. Just like the plumbing is a physical and permanent part of" the structure. It should have been classified under MACRS as Residential Rental Real Estate and depreciated over 27.5 years, same as the structure. Since you sold the property, going back to change that now is a waste of time and will not help you on the tax front. More than likely, it would hurt more than help.
When you sell the property, you are required to recapture the *higher* of depreciation taken, or the depreciation you should have taken, and pay taxes on that recaptured depreciation in the year you sell. Since what you actually claimed for depreciation is higher, that's what you have to recapture. So just leave the current setup alone since you sold it.
at some point I have to claim the depreciation when I sell?
Contrary to what you may have been told in the past, depreciation is not, and never has been a permanent deduction. When you sell business property (and rental property is a type of business property) you are required to recapture all depreciation taken, or the depreciation you should have taken (whichever is higher) and pay taxes on it in the year of the sale.
Recaptured depreciation is taxed as "ordinary income" anywhere from 0% to a maximum of 25%. What your tax rate on the recaptured depreciation is, depends on the numbers (AGI and the such). Whereas your gain on the sale of the property is taxed at the capital gains tax rate.
Two things about recaptured depreciation:
1) Recaptured depreciation is added to your AGI. So there's the potential it could bump you into the next higher tax bracket.
2) Recaptured depreciation is taxed at the ordinary tax rate, anywhere from 0% to a maximum of 25%. So if the income from the sale combined with the recaptured depreciation puts you in a tax bracket above 25%, then it helps. Otherwise, it makes no real difference. But still, the SEC 1250 gain on the sale will be taxed at the capital gains tax rate. For some, that rate is higher than the ordinary tax rate. For others it's lower. It just depends on the numbers.
Sorry I'm not understanding.. Appreciate the help!
No apologies necessary, as it's not like you learn this stuff through osmosis. I certainly didn't. 🙂
