How to Legally Wipe Out Depreciation Recapture

Picture this: you're sitting across from your accountant, coffee in hand, and they just told you that you might owe hundreds of thousands in taxes on a property sale you thought was a win. That knot in your stomach? We've seen it before.

Just last week, one of our clients called us in a panic. He had sold a property he purchased 30 years ago for $300,000. The sale price? Just under a million dollars. Sounds like a great outcome, right? Well, here's where it gets complicated.

Over those three decades, he had taken depreciation deductions on the property. By the time he sold, his basis had dropped to essentially zero. For those unfamiliar with the term, depreciation recapture is the IRS's way of clawing back some of those tax benefits you enjoyed over the years. And with a basis near zero on a property worth nearly a million? That's a significant tax bill waiting to happen.

But here's where good planning made all the difference.

His wife had passed away three years earlier. Both of their names were on the property, and when she passed, her share transferred to him. This wasn't just a sad moment in his life; it was also a pivotal tax event.

The tax code explicitly states that depreciation recapture does not apply to transfers at death. Read that again, because it's important. When you inherit property from a spouse who passes away, any depreciation they claimed gets wiped clean. No recapture. It's gone.

Because we had helped them setup the property ownership correctly years ago, with both spouses on the title, and because she didn't transfer the property to him before her passing, the slate was wiped clean at the time of her death.

But wait, there's more good news. He also received what's called a step up basis. The property's value at the time of her passing was $950,000. He sold it for $970,000. So instead of paying taxes on nearly a million dollars in gains, his taxable gain was only $20,000.

That's the power of proper taxplanning.

Now, one thing to keep in mind:any depreciation taken after that step up in basis is still subject to recapture. The reset only applies to what came before. So ongoing planning remains essential.

The lesson here? Tax planning isn't something you do the week before a sale. It's something you build into your strategy from the beginning. The right ownership structure, the right timing, the right guidance. These details can mean the difference between a tax bill that makes you wince and one that lets you breathe easy.

If you're thinking about selling real estate or a business, please reach out to us before you sign anything. A quick conversation could save you hundreds of thousands, if not millions, of dollars. And honestly? That's the kind of news we love to deliver.

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