depreciation recapture / property transfer / divorce

[Daniel Murphy]

Hey all, we recently did a cost seg & bonus deprecation on our STR for about $180k worth of deprecation.

Well... it turns out married life may not be married life by the end of 2023.  
Can anyone point me to resources on how deprecation recapture would work if we had to sell the STR?

Or info on any effects of changing ownership of the STR from joint to individual in the case of a divorce?

[Marc Howard]

Hey Dan-

Sorry to hear about the situation you're going through. Divorce can be tough, and dealing with the financial aspects of it, especially when it comes to real estate, can be quite a challenge. So let's try to break this down for you.

In a nutshell, depreciation recapture happens when you sell an investment property for more than its adjusted basis (the original cost minus accumulated depreciation). The IRS wants you to pay taxes on the depreciation you previously claimed as deductions since it reduced your taxable income. The rate at which you'll be taxed on this recaptured depreciation depends on your income tax bracket, but it can be up to 25%.

Now, if you have to sell the STR due to divorce, you'll likely have to deal with depreciation recapture. However, you may be able to avoid it if you're able to do a like-kind exchange (aka 1031 exchange) and reinvest the proceeds in a similar investment property. You can find more info on 1031 exchanges at this link: https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-under-irc-code-section-1031

Regarding the change of ownership from joint to individual, there might be a couple of ways to handle that depending on your state laws and the terms of your divorce agreement. One option could be to buy out your spouse's share or vice versa. Another possibility is to sell the property and divide the proceeds. Just keep in mind that you'll want to consult with a real estate attorney or a tax professional to ensure you're making the right move for your situation.

To better understand your specific case, can you tell me which state you're in? That way, I can try to give you more tailored advice based on your local laws.

Hang in there and best of luck with everything buddy!