@Charlie Moore depreciation would show up on your schedule e. You should have been doing this from the start, and should amend all years that you have not taken depreciation. When you sell, you'll have to pay tax on the depreciation, whether you took it or not, so take it every year.

Just a quick note to those advocating for amending the prior year returns if Depreciation was not declared. Amendments are not an option in this scenario. You must prepare a form 3115 Change in Accounting Method in the current year to correct prior years and get the record set properly for going forward. The form is not for the faint of heart. I recommend the OP engage with a competent CPA or EA to complete the filings. And perhaps look for somebody who is willing to educate because there are definitely some gaps in OPs knowledge.

@Charlie Moore some of your statements lead me to believe you do not understand tax law. As others stated, you need to start claiming depreciation the year your property is put into service as a rental. That is the year you buy and rent out the property. Houses are depreciated over 27.5 years. You only depreciate the structure value. For example if you buy a house for $300,000 and the land value is $50,000 that means you depreciate $250,000 over 27.5 years (250,000/27.5=9091 per year). So in this example you would be able to claim $9091 worth of expense in a full year, which would help offset income (rent collected). When you sell the property, all the depreciation you claimed is recaptured and added to your gain, which becomes taxable. The problem is that even if you decide to never claim depreciation, you still must recapture and pay taxes on it. This law absolutely applies in your case where you are renting two houses. Maybe this doesn't make sense to you, but I assure you ignorance of the tax law does not exempt you from having to follow the law. If you have never claimed depreciation, I suggest you work with a CPA to amend your returns and get this corrected. I really recommend all starting investors use a CPA, because there are so many things you can miss or get wrong. You will probably end up paying less taxes if you hire a CPA so it is a good thing.

@Charlie Moore it's called recapture. When you sell, you will add back all of the depreciation as part of the sale.

@Charlie Moore yes, you need to take the depreciation. You will pay the tax for it whether you take it or not, so take it.

Just to make sure I understand your point of view on this.... you're going to continue to try to get free help from the web and not pay a professional to help you out? Also, Joe understands it perfectly well. Your issue may be that you will refuse to be educated on this topic unless or until you find somebody who just agrees with you. Best of luck to you.

Yes, you are confused. This is from ignorance of the law. #1 - The IRS does not care if you are confused. They consider it your responsibility to become educated. They call it fraud when you screw it up, and can enforce penalties, interest and even jail time - that's how they got Al Capone. If you don't like that, the appropriate channel to complain about it is through your elected representative. #2 - You are missing a tax deduction annually by not claiming allowable deprecation - so you are paying more each year than you need to. #3 - When you sell, the IRS requires you account for the depreciation claimed along the way, or depreciation you should have taken along the way (for people like yourself who ignore the rule), so you are required to pay at sale. #4 - If you refuse to do these things, you are committing tax fraud - Annually by overstating your income each year, and finally by understating your capital gain at sale. #5 - I'm going to guess part of your confusion is caused by the "two-touch". It does seem strange that a person would get a tax break at one point, only to pay taxes on that same amount later - I get how that could seem strange - but it is what it is. My advice, is to keep very accurate records. You will also need a source to account for the value of the land, the municipal assessment will do. A CPA chimed-in here and has said you might need to do more than an amended return at this point - have fun with all that. Maybe after you go through some troubles with this stuff, you will take all of it more seriously. I have always done my own taxes and am pretty decent at it. As a very foolish move, because I was caught up in all the other stuff that goes with this business, I failed to file partnership returns for two years. I went back and fixed that after I realized my blunder (very embarrassing, very out of character) and the IRS penalized me almost $5000. Keep in mind, I still reported every penny, and paid every penny of tax owed, I simply reported the income on the wrong form in the wrong way. $5000 for the wrong piece of paper my friend.

OP: You really need to just have someone else do your taxes based on your level of understanding. Not only to keep you out of trouble, but also to keep you from paying what you don't/shouldn't be paying. Depreciation is one of the gems of owning real estate in the first place - it's the paper devalue that lowers your taxable income. It's not a complicated formula - you deduct about 3.64% of the value of the structure (land is excluded) every year for 27.5 years. At that point the IRS considers the property fully depreciated (meaning it has zero value as an asset). Of course, we all know that in reality you will likely make money on that property when you sell it, so when you do the IRS claws back all of that benefit they gave you on depreciation. Since the IRS assumes everyone takes the deduction, they add it back into your taxable income when (if) you sell depending on what year. When you calculate depreciation (virtually all tax programs do this for you), you work off the basis of the structure only. You can usually calculate the basis from your county's tax card - either they give you the basis, or you calculate it on your own. Calculating your basis from your tax card: House/structure value divided by total assessment, as a percentage, times what you actually paid. Example: Your county says the total appraised value is $100,000 - $90,000 for the structure and $10,000 for the land. $90,000/$100,000 = .90, or 90 percent. So let's say you bought the place for $100k plus $5k in associated closing costs. Your basis is going to be: $105,000 x .90 = $94,500. That's your basis in the property. You are going to depreciate ~3.64% of that every year for 27 years. So every year on your Schedule E you are going to have $3,440 of depreciation for this property. If the property rents for $500 per month, and assuming you had no other expenses (not true, but for illustration purposes), you are going to show an annual income for that property of $2,560 instead of $6,000. That $3,440 depreciation deduction will show up every year on your taxes. If you sell the property, all of the depreciation deduction you took (or didn't take, if you screwed that up) from the time you bought until the time you sell is going to be added back to your taxable income, because it was deducted each year. So in this case if you sold this house after 10 years, you're going to add $34,400 to your taxable income ($3,440 x 10 years of deductions). That plus any capital gains on the sale of that house might make it a really painful transaction - especially if you didn't take advantage of the tax write off each year.

@Charlie Moore Income taxes. Are you taking depreciation in your schedule E federal income tax form? Do you do your own taxes each year? How many years have you owned rental property and not taken depreciation on your Schedule E? For example, let’s say your depreciation is $5,000 per year (most building depreciation is taken over 27.5 years). You don’t take that $5k for the last 10 years and then you sell. The IRS will assume you took that $50,000 in depreciation and make you recapture that depreciation in the year of sale. Depending on your tax rate, that could cost you easily $10-15,000 in taxes. I highly recommend you consult with a CPA. I am not a cpa, but I hire one to do my income taxes. Do not try to fix this on your own!

How can I show depreciation for my properties? Tips?

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How can I show depreciation for my properties? Tips?

Charlie Moore

Rental Property Investor · D.C · Member since 2019 · 501 posts · 102 votes

- Any advice?

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Anthony Wick

Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes

@Charlie Moore

You need to consult with a CPA immediately. If you have not been declaring depreciation every year on your rental property you are literally flushing money down the toilet. And you will get smoked on taxes when you sell. Recapturing depreciation is mandatory by the IRS, whether or not you took the tax break in the first place.

Again, the IRS assumes you took the depreciation every year, so they make you recapture the amount when you sell. There is no stating “but I didn’t take depreciation”.

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Maximilian Glodde
Chartered Financial Analyst (CFA) · Boston, MA · Member since 2018 · 40 posts · 14 votes
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@Immanuel Sibero I think you misunderstood my point. If you sell for $20K after 10 years, a zero gain on paper, since the OP didn't take a deduction for deprecation, he would be liable for depreciation recapture since the cost basis is now lower. We're saying the same thing. Have a good night. Thanks for the great discussion.
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Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
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@Charlie Moore you need a real estate savvy CPA
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Immanuel Sibero
Carrollton, TX · Member since 2015 · 415 posts · 371 votes
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Originally posted by @Maximilian Glodde:
@Immanuel Sibero I think you misunderstood my point. If you sell for $20K after 10 years, a zero gain on paper, since the OP didn't take a deduction for deprecation, he would be liable for depreciation recapture since the cost basis is now lower. We're saying the same thing. Have a good night. Thanks for the great discussion.
My bad... I was looking from the IRS perspective. I missed the zero "paper" gain you pointed out. When selling for 20k, the OP does in fact have a gain, as defined by the IRS, which would trigger the recapture rule. A zero gain or loss (by IRS definition, to be clear) would not trigger it.
Yes.. have a good night.
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Bill White
Investor · Flower Mound, TX · Member since 2016 · 17 posts · 17 votes
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@Immanuel Sibero
I think you may be confusing the depreciation expense vs gain on sale.
The depreciation expense is taken yearly against your income. The amount depreciated is recaptured when the property is sold (FYI just 1031 exchange it till you die. Your kids get to start depreciation over again at new home value and never have to pay your depreciation from before and can’t 1031 forever, and so on).
If you sell your rental at a loss then you can apply a portion against what you owe, but like everything there are nuances. So without knowing all the details it’s hard to give you a complete answer.
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Immanuel Sibero
Carrollton, TX · Member since 2015 · 415 posts · 371 votes
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@Bill White
Thanks for responding. What I was observing people are saying in this post (maybe I'm misinterpreting) is that "depreciation recapture" is some additional income that is taxable when you sell. My understanding is this depreciation recapture is just an amount used to determine how much of your gain on sale will be recharaterize from capital gain to ordinary income. So the recapture amount is not some additional taxable income on top of your gain on sale.
This also explains why the recapture rule does not apply when you have zero gain or loss on sale. Correct?
Yes, 1031 exchange is nice but quite restrictive.

Thanks again.
Cheers... Immanuel
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Bill White
Investor · Flower Mound, TX · Member since 2016 · 17 posts · 17 votes
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@Immanuel Sibero
I would suggest that you forget the terminology on whether or not it’s income. Search adjusted cost basis. If you’ve had a rental for a decent period of time it’s unlikely you will have a loss (tax purposes). Here is an example of what I think you are getting at:
Sale price: $200k
Adjusted cost basis: Purchase price $220k + renovations $10k - depreciation $40k = $190k
$200k-$190= $10k gain so $2.5k tax (est. 25% tax rate)
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Immanuel Sibero
Carrollton, TX · Member since 2015 · 415 posts · 371 votes
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@Bill White
"I would suggest that you forget the terminology on whether or not it’s income."
Couldn't agree more. That's what's confusing about this thread. Everyone is calling "recapture" taxable income.
I'm going to use your example with slight change to illustrate what I'm trying to say, let's say Sale price is $300k (this is quite realistic in the DFW market) so:
Sale price: $300k
Adjusted cost basis: Purchase price $220k + renovations $10k - depreciation $40k = $190k
Gain (assuming long term) is $300k - $190k = $110k
Under the recapture rule, here is what happens to the $110k Gain: $40k will be taxed at Ordinary Income (whatever bracket I'm in) and the rest which is $70k will be taxed at Cap Gain Rate (i.e maxes out at 20% in 2018).
Cheers... Immanuel
PS. I'm interested in this because I'm considering selling one of my rental house... I have never sold one before.
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Bill White
Investor · Flower Mound, TX · Member since 2016 · 17 posts · 17 votes
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@Immanuel Sibero
You’re on the correct path.
Depreciation recapture is considered “income” but don’t let that confuse you on what’s going on the important calculations.
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Immanuel Sibero
Carrollton, TX · Member since 2015 · 415 posts · 371 votes
7y
Originally posted by @Bill White:

@Immanuel Sibero
You’re on the correct path.
Depreciation recapture is considered “income” but don’t let that confuse you on what’s going on the important calculations.
Thanks. It really doesn't sound as bad as what some of the posts suggest.
Cheers... Immanuel
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