Will I have to pay recapture tax on the depreciation of rental property I sold?

Oct 02, 2017

I sold a rental property for a profit this year, and I want to make sure that I understand the tax implications. I paid $195,000 for the property and sold it for $325,000. I understand that I will have to pay capital gains tax on the profit, less the real estate broker commissions, etc. The depreciation on the property was about $7,200 per year, and it was active for five years. Also, I have about $21,000 in disallowed losses that have accumulated because my income is above $150,000. If I am understanding correctly, I will have to pay 25 percent recapture tax on the $36,000 depreciation. And the $21,000 in losses will be taken against my ordinary income? Please let me know if I am correct.

Congratulations on the sale of your rental property! Your understanding of your tax situation, as you laid it out in your question, is correct. The taxable gain that you realized upon the sale of your rental property would be $166,000 ($325,000 of proceeds less your adjusted basis of $159,000), given the facts above. You would also subtract from the proceeds any expenses you incurred to sell the property, such as real estate broker commissions, real estate transfer taxes, any costs you paid on behalf of the buyer (buyer assist), etc.

Of the total taxable gain that you realized, a portion of the gain is purely due to appreciation of the property, and the other portion is as result of depreciation deductions you have claimed while you owned and rented out the property. The portion of the gain attributable to depreciation is called Section 1250 capital gain, and it is taxed at a rate of 25 percent. The portion of the gain related to appreciation on the property while you held it would be long-term capital gain, which would be taxed at a rate of either 0 percent, 15 percent, or 20 percent, depending upon your federal income tax bracket.

Finally, any rental losses that had been previously disallowed because of the passive activity loss rules will now be allowable because you have completely disposed of the rental activity. Accordingly, you will be able to deduct your suspended losses of $21,000, and these will offset your other ordinary income, such as your wages, interest and dividends, etc.
For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: James G. McGrory, CPA, and Stephanie K. Otake, CPA, are with Drucker & Scaccetti in Philadelphia.
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