The depreciation you take reduces your basis in the property, potentially resulting in more capital gains when you ultimately sell. Here's what you need to know. And because the IRS requires you to recapture your depreciation, you come out with a gain of $5,000—not terrible! 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. 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. The U.S. government will not allow you to deduct losses in value from the time period before the rental conversion. 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. 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. Turning Your Rental Property Into A Primary Residence 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. 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%. 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. By taking a depreciation deduction, you reduce the cost basis of your home. For a rental home, you may deduct 3.64 percent of its purchase price each year. 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. That means you get an annual deduction of that depreciation amount from your revenues. So don’t think, “we just won’t take the depreciation.” I love the logic, but the IRS disagrees… Other Taxes. Depreciation is recaptured. You will still owe the taxes when you sell the property. 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 a depreciable property through a 1031 exchange, special depreciation recapture rules can apply. Depreciation is recaptured at the time of sale, whether you took the depreciation or not. When you sell the property, you … For more information, check out our in-depth guide to 1031 exchange rules in real estate. Depreciation recapture can cause a significant tax impact if you sell a residential rental property. 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