Should I claim depreciation on rental property that I passively manage

Question

I own a rental condo that I used to previously occupy. My income from rental property is largely offset due to depreciation. However, I can not show loss against my active income as my joint income is well above the threshold of 150K and I am not a real estate professional (so cant claim it nonpassive activity)

Should I still claim the full depreciation? my Income is unlikely to go below that threshold of 150K in next 2-3 years. I am likely to hold on to this rental condo as market are recovering for next 10 years. I would also like to purchase additional property. I usually do taxes by myself but open to going to cpa. What kids of questions should I ask to them if I were to hire them. Thanks in advance

Ali Boone · Answer

Definitely always ask a pro tax questions. Filing taxes are a bad place to make a mistake!

Duncan Taylor · Answer

Take the depreciation. Carry the loss forward until your income level allows the write off to be taken. If you still have a carry over amount available when you sell it can be used to offset the required recapture.

Under IRS rules, you must recapture depreciation on real estate when you sell... whether you took the depreciation deduction when available each year or not.

With your income level and the complexity of the continuing carry over, you really need to talk to a CPA familiar with this type of situation. If you don't do it right, you will pay more tax than you should.

Jon Holdman · Answer

Capital gains tax rate is currently 25% for short term (under a year) and 15% for long term, over a year.  Its the tax on unrecaptured depreciation that's currently capped at 25%.

So, in my example you would pay 25% on the $36,363 of unrecaptured depreciation plus 15% of the remaining gain of $25,000.

Bill Exeter · Answer

Yes, absolutely.  You will be assessed depreciation recapture whether you have written off the depreciation or not.  You will lose out if you do not depreciate rental/investment property.

Xing Zhu · Answer

If you use Turbo Tax, all these will be calculated for you.

The following article explains some of the changes of  rules for 2014.

http://www.fool.com/how-to-invest/personal-finance/taxes/2013/12/19/be-prepared-for-the-capital-gains-tax-rate-in-2014.aspx

Rid Shah · Answer

Thanks @Jon Holdman

That was very helpful. So in your example, capital gain tax at 25% rate (capped at max ordinary income rate) would apply on $25000 ($125K-$100K). What rate would apply to $36,363 of gain?

Roy N. · Answer

Well, doesn't that change everything.  Here there is not cap on recapture, it is taxed at your marginal tax rate.

Does the same hold true for properties held corporately?

Jon Holdman · Answer

Absolutely you should claim depreciation.  Why?  Because when you sell, the basis for your property will be decreased by the amount of depreciation taken or allowed, which ever is greater.  You will then pay tax on the unrecaptured deprecation, up to the amount of deprecation taken or allowed, again which ever is greater.  This tax is at your ordinary income rate but it is currently capped at 25%.

So, if your basis when you converted it to a rental (a somewhat complicated issue in itself) is $100K and you hold for 10 years you will have $36,363 of depreciation allowed.  If nothing else has happened, your basis is now 63,637.  If you sell for, say, $125K, you would have $36,363 of gain subject to the tax on unrecaptured depreciation and then another $25K subject to capital gains.

Even though you can't deduct those passive losses against ordinary income, they do carry forward.  Then, when you sell, you can deduct those passive losses against the gain.  The sale doesn't even have to be the same property.  If you have several rentals, all generating carry forward passive losses, and you sell one of those, you can apply all your carry forward passive losses to the sale.

Roy N. · Answer

I too am curious to see the difference in approach recommend in the U.S.A versus here in Canada.

In Canada, if you hold the property in your name, then it is usually - but not always - a bad idea to take the Capital Cost Allowance {the CRA's fancy term for depreciation} on your taxes.  The sole exceptions to this would be if you were absolutely certain you would be in the same, or higher, tax bracket when your sell the property {Oh, Magic 8-ball, what say you?} or you were absolutely certain the property will sell for less than your un-depreciated capital costs {not typically the outcome we desire when selling}.

The reason for this is that the CCA (read: depreciation) will be recaptured at the time you sell the property {the delta between the depreciated value and the un-depreciated capital costs or the sales price (whichever is lower)} and added to your income for that year.

If you hold the property in a corporation, the corporation would typically claim the CCA since passive income in a corporation is taxed at the highest marginal corporate tax rate; meaning the tax rate at the time of sale will be the same, so you may as well pay those taxes using tommorrow's dollars than today's.

Tyrus Shivers · Answer

@Rid Shah

I leave those questions to a qualified accountant or CPA as I am not an expert.

@Steven Hamilton can provide more insight.

Should I claim depreciation on rental property that I passively manage

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