PHILADELPHIA - Understanding the new rules regarding depreciation recapture is important if you own rental properties. You should keep detailed records of all property expenses, including mortgage interest and repairs, and talk to a tax advisor to determine if depreciation recapture is right for you. You can also consider the cost segregation study and the new proposed rules.
Cost Segregation Study
Cost segregation studies are important for maximizing depreciation expense deductions and increasing after-tax cash flow. The process involves analyzing different building components. For example, non-structural components of a building are treated as personal property since they have a shorter useful life. Personal property assets include signage, wall coverings, special doors, countertops, lighting, and equipment. Depending on their shielding, some walls can also be treated as personal property.
A cost segregation study is necessary to identify assets eligible for accelerated depreciation. This process can provide large depreciation deductions to the current owner of a building. However, the recapture rate is higher, so an increased tax bill should be considered when selling the building.
A quality cost segregation firm will perform a detailed engineering approach based on actual cost records and an itemized cost estimate approach. The IRS recommends both methodologies. However, sloppy work or weak evidence will raise red flags with the IRS. Therefore, hiring a firm with experience in cost segregation is critical.
Taxes On Depreciation Recapture
One benefit of depreciation recapture is that it reduces the landlord's taxable income. This reduction is paid in addition to capital gains taxes. Rental property depreciation recapture is capped at 25%. However, it can be a confusing concept for first-time landlords.
The first step is to understand depreciation recapture. Rental property owners are able to deduct most expenses in the year of purchase, but they should note that depreciation is not always fully deductible. It's important to deduct expenses over the life of the property so that the deduction is spread over its useful life. This method applies to both residential and commercial rental properties.
While depreciation can save real estate investors money in the short run, it can reduce their profits when it comes time to sell the property. Therefore, it's important to understand how depreciation recapture works before making an investment decision. If you're unsure about how depreciation works, take our 50-minute online training course to learn the details.
Benefits Of Depreciation Recapture
If you own rental property and are interested in deferring taxes, you may wonder if the new law will help you. You will indeed need to pay tax on the property's full value when you sell it, but depreciation deductions will help you save money in the long run. Depreciation deductions can help you reduce your reported income by a significant amount.
Depreciation begins when you buy or place investment property into service. However, if you plan to use it as your primary residence, you will not have to pay depreciation for that year. Instead, you can begin marketing it for rent in the middle of the month and get about 2 1/2 months of depreciation.
Another great benefit of depreciation is that it can lower your taxable income, which means you'll be able to sell your rental property for more money than you spent on it. Depreciation is a great tool for rental property investors, whether you make a profit or lose money. However, the tax laws for rental properties are complicated, so it's a good idea to work with a qualified tax accountant. They will be able to advise you and help you get the most favorable tax treatment possible.
Impact Of Proposed Rule Changes On Depreciation Recapture
The budget proposal requires the recapture of real property depreciation as ordinary income when it is sold. This new requirement applies to any real property held by a taxpayer for more than one year. Prior to the proposed rule change, this gain was taxed at a preferential rate. The proposed rule change would only affect depreciation taken after 2022 and would affect taxpayers with income over $400,000.
Another important change to the depreciation rules is the introduction of bonus depreciation. This new rule may create new opportunities for renewable energy investors. This change may also require tax equity investors to re-evaluate their partnership deficit restoration obligations.
Under the new rules, qualified rental properties will be entitled to a bonus depreciation of up to 100 percent. However, there are exceptions to these rules. Certain aircraft and longer production-period properties will not be eligible for bonus depreciation. In addition, the taxpayer's property must not have been used before it was acquired. Further, it must not have been acquired from a controlled group of corporations or a related party.
