1031 / depreciation recapture question

[Gabe H.]

I've tried searching the forums, but couldn't find an exact answer to this question. 

Depreciation reduces the cost basis of your property, and has it's own, 25% depreciation recapture tax rate when you sell. 

So if you bought a house for 100k. Have 50k depreciation and sell for 200k, you get taxed on the gain of 150k. 50k@25% for depreciation recapture and 100k@15% for capital gains. 

If you do a 1031 and buy a new property for 400k, your new basis is 250k. 

Question 1) does the depreciation recapture follow thru the 1032 exchange where you still keep track 50k worth of recapture? Or does the basis reset with the new property?

I assume you keep the capital gains/depreciation itemized. Where you add the 50k deprecation amount to any future depreciation. But obviously it would be better to pay capital gains instead of depreciation recapture. 

Question 2) the depreciation rate of the new, 400k property is independent of your basis going into the new property right?

Where it's still based on the structures value over the 27.5 years.

Thanks for any help, I appreciate you taking the time to read and reply!

[Dave Foster]

@Gabe H., When you do a 1031 exchange the basis of the old property is transferred to the new property.  So the depreciation follows it.  If you purchase more than you sell then you are adding additional depreciable basis.  Your accountant uses the form 8824 to report the tax deferral and set up the new depreciation schedules.

As to your other question...Dude. Seriously?!  (just kidding you some of these benefits are indeed counter intuitive because so many of the gurus and experts out there only focus on the obvious).  But what do you call an interest free loan that you never have to pay back ---- A gift!!

OK get the easiest out of the way - Depreciation does give you a current year write off.  That reduces current taxes.  If you continue the deferral until death then that tax reduction does happen.  Along with that the 1031 exchange also allows you to defer tax on the gain.  And again if you continue until death the tax disappears.  So again a direct tax reduction.

And yes, if you just put a renter in that fix n flip for a while you will convert the ordinary income of a fix n flip into a capital gain.  Again a real reduction in tax over the same profit.

How about the principle repayment paid for by your tenants.  Those are real dollars back in your pocket and they're tax free.

And while we're on the subject of tenants.  All of those expenses to keep up the property are deductible from the rent paid by the tenant so they reduce taxable income which directly reduces taxes.  But their benefit is to keep up the value of the property so the depreciation you've been taking the benefit of isn't real

Think of your home as an investment.  It builds appreciation while you own it and the mortgage interest is generally deductible.  And when you sell it if you meet the primary residence requirements the profit is tax free.

It is possible in many instances to own successful rental real estate that generates real dollars in your pocket but operates at a loss for tax purposes.  That is real tax savings.  The government has set it up so that if you use some good accounting strategies you can avoid payment of tax for your life.  And then your heirs get the properties tax free.  Again a real reduction of taxes.

My favorite of all time though is my client who did a 1031 of a farm and bought investment properties in each of the three cities where their children lived (tax deferral).  The children managed them under the agreement that they would inherit them (tax free). Tenants paid all expenses (tax write off) including the mortgage pay down (tax free).  The couple makes more money than they ever did farming (OK not a tax break still tres cool).  And Grandma now gets to write off business trips to go see the grand kids every year.  

Yes this is a great country :)