What is tax recapture when selling an investment property?
Tax recapture occurs when you sell a property that you have been depreciating for tax purposes and you have claimed a tax benefit from that depreciation. When you sell the property, the IRS requires you to "recapture" that tax benefit by including it as income on your tax return for the year in which you sold the property.
Here's an example:
Let's say you buy a rental property for $100,000 and you claim $10,000 of depreciation on your tax return each year for 5 years. This means that you get to reduce your taxable income by $10,000 each year, which saves you money on your taxes. Now let's say that you sell the property for $150,000 after 5 years. When you sell the property, you have to include the $50,000 of depreciation that you claimed as income on your tax return for the year of the sale. This is called tax recapture.
The tax rate for recapture is generally the same as your ordinary income tax rate, so it can be a significant cost when you sell a property that you have been depreciating. However, you may be able to avoid or reduce tax recapture if you sell the property at a loss or if you qualify for certain exemptions or exclusions, such as the exclusion on the sale of a primary residence.