Depreciation Recapture on Real Estate refers to the process by which the IRS recaptures the tax benefits received from depreciation deductions when a property is sold.
When an investor claims depreciation on a real estate property, it reduces the taxable income during the period the property is held. Upon the sale of the property, the IRS requires that the depreciation taken be "recaptured" and taxed as ordinary income up to the amount of gain realized on the sale. This means that the portion of the gain attributed to depreciation will be taxed at a maximum rate of 25% instead of the lower capital gains rates that apply to the appreciation in value beyond the depreciated value.
For example, if an investor bought a rental property for $300,000 and claimed $100,000 in depreciation over the years, the adjusted basis of the property would be $200,000. If the property is sold for $400,000, the total gain would be $200,000 ($400,000 sale price – $200,000 adjusted basis). Out of this gain, the first $100,000 would be subject to depreciation recapture taxation, while the remaining $100,000 would be taxed as capital gains.
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