For more information, check out our in-depth guide to 1031 exchange rules in real estate. You will still owe the taxes when you sell the property. The other part of the building gets treated as an investment property, meaning that you must pay both the 15 percent capital gains tax and the 25 percent depreciation recapture tax. One of the benefits of having a rental is the ability to claim depreciation on the property, which allows you to offset rental income that would otherwise be taxed as ordinary income. Although you may think that you can get around the personal-residence rule (described above) by simply converting your home into a rental property before selling, this only works to a point. For a rental home, you may deduct 3.64 percent of its purchase price each year. Rental property depreciation can lead to huge savings when you file taxes as a property owner. The U.S. government will not allow you to deduct losses in value from the time period before the rental conversion. That means you get an annual deduction of that depreciation amount from your revenues. Depreciation is recaptured. And because the IRS requires you to recapture your depreciation, you come out with a gain of $5,000—not terrible! By taking a depreciation deduction, you reduce the cost basis of your home. So don’t think, “we just won’t take the depreciation.” I love the logic, but the IRS disagrees… Other Taxes. The IRS considers a rental property to have an expected life of 27.5 years.To calculate your annual depreciation percentage, divide one by the life of your asset. We've discussed the process of selling a house you live in, but selling a rental property is an entirely different bird. There are many other ways to utilize tax deferred strategies to avoid depreciation recapture taxes and capital gain taxes, but can be complicated to explain and so are beyond the scope of this article. If you made improvements to the property while it was a rental, you would list this as an asset - and depreciate it. If you sell the property for $95,000, you will have a $0 gain and will not have to pay recapture taxes on that $5,000 of depreciation. Part of the gain is taxed as a capital gain and might qualify for the maximum 20-percent rate on long-term gains, but the part that is related to depreciation is taxed at the higher tax rate of 25%. So, during the course of your rental, you depreciate the property, generally over 27.5 years. Here's what you need to know. When you sell the property, you … Depreciation is recaptured at the time of sale, whether you took the depreciation or not. It’s quite likely, with the current property boom, that when you sell your rental property it will be sold at a profit, when the sale price exceeds the original cost price. If you sell a depreciable property through a 1031 exchange, special depreciation recapture rules can apply. 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