Depreciation Recapture

[bruceinla]

The regular expenses on my rental property already exceeded the income I received over the years I rented the property. The Depreciation Report shows a lot of depreciation that I never got to use because you can't take a loss on rental property. This year I sold that rental property. I'm thinking that the depreciation from that report for the years I did rent it is irrelevant (no depreciation recapture) because my gain on sale is a capital gain which can't be offset by the QBI losses I've incurred over the years, which would include the depreciation.  So...am I correct that I don't have to pay tax on depreciation that threw me into a loss or do I take the operating losses and then pay depreciation recapture on what's on the Depr Report? 

[DianeW777]

It depends. In any tax year you are allowed to take a loss on rental property unless your rental property was a 'not for profit' activity. This means all income was reported and no expenses were allowed.

Assuming your property was a 'for profit' activity continue:

Be sure any passive loss carryover is recorded in your tax return if applicable. Look for Form 8582 from your prior year return (2023).  This should have your accumulative carryover numbers for your current year tax return.  You should have one form for regular tax, and a second for alternative minimum tax (AMT) if you have any.

Review page 2 of your 2021 Form 8582 for the passive losses you have to carryover.

If your rental property was a 'for profit' activity, even though you had losses, the depreciation would be considered and recaptured.  If the passive losses were limited due to your income level they would have been carried over until you sold the property and used them up.  See the passive loss limits and phaseout next.  If your income was below the limits noted in all years then you used your losses each year up to $25,000. This would have included all depreciation.

• Phaseout Rule: The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that’s more than $100,000 ($50,000 if you’re married filing separately). If your modified adjusted gross income is $150,000 or more ($75,000 or more if you’re married filing separately), you generally can’t use the special allowance. This is because the special allowance is reduced to $0 since the modified adjusted gross income is over the $100,000 amount.

TurboTax will calculate your gain using your original cost reduced for all depreciation for all years as a rental property, plus sales expense.  The steps to enter the sale in your tax return in the rental activity are shown below. 

Sign into your TurboTax return to enter the sales information:

Under Income select your Rental Income > Edit > Continue to the screen 'Tell Us More About This Rental Asset'. Select that you purchased it, also select the item was sold, retired, ...., etc. > Yes always used 100% for business if there was no personal use during ownership since the rental activity began.

For multiple assets - Calculate Selling Price for each:

To figure out the selling price for each asset:

1. Take the current basis of each asset against the total combined basis of all of your assets to figure out the sales price for each one; OR 
2. Determine a fair market value for each asset against the total value of all assets to figure out the sale price for each one. 

Use the original cost of each asset listed on depreciation, add those together then divide each one by the combined total to find the percentage of the cost for each asset.  Use that percentage times the sales price and sales expenses to find the selling price/sales expenses for each asset. (Choices would also be fair market value on the date of the sale or adjusted basis on the date of the sale, which is cost less depreciation.)

Example:  Original Cost (of each asset on your depreciation schedule)

$10,000 Land                = 13.33% 

$50,000 House              = 66.67%

$15,000 Improvements  = 20%

$75,000 Total                 = 100%

Multiply each percentage times the sales price/sales expenses to arrive at each individual sales price/sales expense.