When Depreciation Goes "Poof"

Bozo | May 28, 2017 | 1,375 posts since 2011

Many DA readers own alternative investments (i.e., other than CDs). For those who own real estate investments, such as a condo or house rented to others, depreciation is factored in on Schedule "E". Even with a cash-flow positive property, depreciation will often shelter the income from tax.

Without getting into the nuts and bolts of IRS Form 8582 (where you can shelter ordinary income if your MAGI is below $150,000), a major wrinkle in the Tax Code allows you to avoid all depreciation recapture. Problem being, you must be dead.

While alive, if you sell a property where you have depreciation (whether taken or not), that depreciation is taxed at 25%. On the other hand, when you die, your heirs get a step-up in basis, the depreciation is wiped off the map, and the tax man gets stiffed.

Post a comment

gbtexas | May 28, 2017 | 78 posts since 2013

Excellent job, Bozo. This, of course, is one of the main reasons, should one own several particles of real property with depreciable structures to hold on to them. The problem, though, as many know, it generally doesn't override sound economics such better alternate opportunities, declining values, etc. Then to top it off, with depreciation of most real structures being very long life with only straight line depreciation being allowed, it's tantamount to watching paint dry. No matter, Bozo, as he generally does, presents a superb case for holding till death do we part.

Bozo | May 29, 2017 | 1,375 posts since 2011

gbtexas, being able to hold one's MAGI as close as possible to $100,000 is really the key. IRS Form 8582 refers. For retirees, it is important to note that Social Security payments do not count towards MAGI on Form 8582. Thus, it is quite conceivable that a married retired couple, with dual RMDs and Social Security payments, might still fall within the $100,000 - $150,000 range and be able currently to shelter some ordinary income with booked losses from depreciation. It's sort of a weird factoid from the Tax Code. You can eat your cake now, but the cake magically reappears when you die.

The step-up in basis for depreciated investment real property is one loophole in the Tax Code which needs a sharp pencil.

The Tax Code is a mess, but I'll take advantage of it as long as I can.

gbtexas | May 29, 2017 | 78 posts since 2013

Bozo, I'm sure you know that the 150k max to be able to take losses, I believe off the top of my head, has been the same since Ronald Reagan's 1986 tax reform act. This effectively means that the real dollar max limitation is well below 75k when adjusted for inflation.

Tax Code......it is so unweildly that no one person is even close to understanding it

Bozo | May 29, 2017 | 1,375 posts since 2011

gbtexas, I suspect the powers that be are well aware of Form 8582 and its relation to the step-up in basis. By allowing inflation to eat away at the value of the $100,000 - $150,000 range, the "loophole" can be closed gradually, without the necessity of a repeal.

Frankly, I didn't have a clue about Form 8582 until it registered a "negative" some years back on Form 1040, line 17. Were I to hazard a guess, I suspect few taxpayers know about the loophole created by Form 8582, and even fewer purchase depreciable rental real estate property with an eye to take advantage of it. As I noted, the perquisite seems most beneficial to retirees, and most retirees don't exactly go cruising for loophole-generating real estate rental properties.

The financial institution, product, and APY (Annual Percentage Yield) data displayed on this website is gathered from various sources and may not reflect all of the offers available in your region. Although we strive to provide the most accurate data possible, we cannot guarantee its accuracy. The content displayed is for general information purposes only; always verify account details and availability with the financial institution before opening an account. Contact [email protected] to report inaccurate info or to request offers be included in this website. We are not affiliated with the financial institutions included in this website.