How to calculate depreciation and tax burden

[Kasper Rune Søgaard]

I am having some issues figuring out to calculate how depreciation affects my tax for a rental property. I have an example below. Is it correctly calculated correctly?

Example:

• Purchase price: $1,500,000
• Rehab: $100,000
• Land Value: $750,000
• Year 1 interest paid: $41,632
• Year 1 principal paid: $23,029
• Yearly property tax: $18,750
• Annual expenses: $6,200 (Insurance, utilities, gardener, and so on)
• Tax rate: 25%
• The annual rent income is $129,600

The house value is $750,000 (purchase price - land value) + $100,000 in rehab (all just calculated as 27.5 to make it easier), depreciated over 27.5 years is $30,909 a year.

If we calculate our year's profit $129,600 (rent income) + $23,029 (principal) - $6,200 (annual expenses) - $18,750 (property tax) - $41,632 (interest paid) = $86,047

My depreciation is $30,909 a year, I can subtract that from my taxable income. $86,047 - $30,909 = $55,138 I am then taxed on the $55,138 at 25% making this year's tax $13,784.5 That would mean my annual profit is $86,047 - $13,784.5 = $72,262.5 and cash flow $72,262.5 - $23,029 = $49,233.5

Is this correct so far?

Let's say that I hold the property for 10 years and sell it for $1,950,000., meaning that I increase the value of the property by $450,000. And the land value was 50% meaning that the building has increased the value by $225,000.

How do I calculate how the depreciation recapture is taken at this sale?

[Dave Toelkes]

@Kasper Rune Søgaard

First, let's get the terminology correct.  You don't have profit until you sell the property.  You have net rental income which is also called cashflow, and, you have net taxable income.

To calculate your net rental income, or annual cashflow. start with your gross rental income then subtract your out of pocket costs of ownership and rental operation (principal payments, mortgage interest, property taxes, hazard insurance, and other expenses) to get $39,989 using your numbers.  

Your taxable income before depreciation takes your cash flow and adds back your principal payments to get $63,018.  Subtract your depreciation expense to get your net taxable income of $32,109.  In the 25% bracket, the tax on your net taxable rental income would be $8027.

If you take a $30,909 depreciation expense each year for 10 years prior to sale, you would pay a 25% depreciation recapture tax on the $309,090 allowed depreciation in addition to the long term capital gains tax on $350,000 profit due to appreciation.  Don't forget that the increase in your land value is also subject to capital gains tax when you sell the property.