Depreciation Recapture Questions

[Brad Rondeau]

I bought a condo in Laguna Niguel CA in December 2009 (7+years ago).  I lived there one year then bought a bigger home with my new wife.  I continued to own and rent the condo.  Cash flow in coastal CA is very hard to get because property is very expensive and rent is low in comparison.  I started with a small negative and currently have a small $170 positive cash flow per month.

I bought for $365,000 (then added around $17,500 in improvements) and currently could sell with a realtor for about $550,000. 

Well over $11,000 per year of principal is being retired on the 20 year loan.  Same great tenant all these years. He now wants to buy it and I am checking it out.  He wants to buy at about $520,000 which would be fine because I would save on realtor fees and would not have to paint, replace carpets etc (no need to fix up to show the property).

I've saved lots from the $13,635 depreciation per year (13,635 * 7 years = 95,445). But I never knew about the Depreciation Recapture rule. When I sell it I will get a check for about $300,000. I thought all profit/appreciation would be at 15% long term capital gains rate. But it sounds like I will have to pay closer to my ordinary tax rate (25% fed + 9% CA) on the $95,445 that I have already depreciated.  Wow!! Does this sound right?  If so I may retire now to put me in a lower tax bracket for this 2018 sale.  Then maybe start a business in 2019 (I'm currently 58).  

This property was great with the price appreciating and using the depreciation rules to lower my very high taxes. But now it seems if I sell I will have to pay back all the money that I saved from depreciation because of the recapture rule.  Can anyone shed more light on this rule?

I would like the $300,000 but don't really need it.  But the time is right because with these rising interest rates fewer buyers will be able to afford this property in the future.  On the other hand if I keep it for ever I never have to pay back the depreciation savings.  But this will leave me with my small positive cash flow until the 20 year loan is payed off in 13 years.  At that time I will have a huge positive cash flow but do I really want to wait 13 years for that?  

Last year I bought my first mid-west property - Burlington KY (northern KY), this is really a suburb of Cincinnati. I do like the cash flow, I may do another one or two in same area this year.  If I re-invest my profits from CA in new properties in mid-west would that save me from having to pay the depreciation recapture etc?

Any thoughts or insight is appreciated.