I’m in a truly lucky, and privileged position, to be able to afford and own a house in the Bay Area. A bit part of the reason we bought the house we did was because of the way it was structured. It has three floors, and two entrances, and the bottom floor is essentially set up like an in-law suite, with a private entrance, bedroom, full bath, and a sizable laundry room. We saw an opportunity to augment our income with an Airbnb, and decided to jump into the deep end. (I’ll clarify that, because there’s not really a true kitchen, we’d likely never create a permanent rental unit out of this space).
What about losing the primary residence exemption to capital gains tax ($500,000 for married filing jointly)? Have you moved into whether you could only claim as portion of that exemption, based on your rental?
Good question! The house is still our primary residence, so to the best of my knowledge, we don't lose that exemption, but it is true that we eventually will have to pay depreciation recapture taxes on the deductions we've taken, which would have to be paid before we can benefit from the cap gains exclusion. I'm not an accountant, so it's definitely possible I'm wrong here.
Great article my friend! I learnt about the depreciation recapture way late in the game, many years after we had moved from San Diego to Bay Area and rented out our primary home. It has been rented for 6 years now and now I am afraid to ever sell it, because of the depreciation recapture. 1031 Exchange can only help, if you want to buy a new rental property. Do you know of any option, to avoid recapture besides 1031 Exchange?
I think there's a sort of philosophical question behind the question here...does the depreciation recapture matter? Think about it this way: you've received income for rent, and while you've been receiving that rent and deferring your taxes, a) the overall value of your property has probably gone up, and b) you've deferred the taxation, rather than avoided the tax, but that deferral means that you can, in theory, reinvest the income to produce greater returns. So from an overall outlay perspective you're still coming out way far ahead, if you've played your cards right. I realize it's not exactly an answer to your question, but it's food for thought (and obviously will never take away the sting of a potentially large tax bill at the sale).
That said, I haven't done a *ton* of research on the mechanics of depreciation recapture and how to maneuver around it. 1031 Exchanges are the most obvious way to continue deferring those taxes if you want to get out of the property. In theory, you could just hold onto the property for your entire life, and let your heirs inherit it. In that case, my understanding is that the heirs get a stepped-up basis, and don't actually have to pay the depreciation recapture (as usual, IANAL, so don't take this as legal or financial advice please).
I'm in a particularly weird situation because I'm renting out a portion of my primary residence as a depreciable asset, rather than my entire house, and so I perceive a 1031 Exchange to be something that would be really hard to execute on, though once I'm in a place to seriously consider it, I'll probably end up learning a lot more.
What about losing the primary residence exemption to capital gains tax ($500,000 for married filing jointly)? Have you moved into whether you could only claim as portion of that exemption, based on your rental?
Good question! The house is still our primary residence, so to the best of my knowledge, we don't lose that exemption, but it is true that we eventually will have to pay depreciation recapture taxes on the deductions we've taken, which would have to be paid before we can benefit from the cap gains exclusion. I'm not an accountant, so it's definitely possible I'm wrong here.
Great article my friend! I learnt about the depreciation recapture way late in the game, many years after we had moved from San Diego to Bay Area and rented out our primary home. It has been rented for 6 years now and now I am afraid to ever sell it, because of the depreciation recapture. 1031 Exchange can only help, if you want to buy a new rental property. Do you know of any option, to avoid recapture besides 1031 Exchange?
Thanks, Sal!
I think there's a sort of philosophical question behind the question here...does the depreciation recapture matter? Think about it this way: you've received income for rent, and while you've been receiving that rent and deferring your taxes, a) the overall value of your property has probably gone up, and b) you've deferred the taxation, rather than avoided the tax, but that deferral means that you can, in theory, reinvest the income to produce greater returns. So from an overall outlay perspective you're still coming out way far ahead, if you've played your cards right. I realize it's not exactly an answer to your question, but it's food for thought (and obviously will never take away the sting of a potentially large tax bill at the sale).
That said, I haven't done a *ton* of research on the mechanics of depreciation recapture and how to maneuver around it. 1031 Exchanges are the most obvious way to continue deferring those taxes if you want to get out of the property. In theory, you could just hold onto the property for your entire life, and let your heirs inherit it. In that case, my understanding is that the heirs get a stepped-up basis, and don't actually have to pay the depreciation recapture (as usual, IANAL, so don't take this as legal or financial advice please).
I'm in a particularly weird situation because I'm renting out a portion of my primary residence as a depreciable asset, rather than my entire house, and so I perceive a 1031 Exchange to be something that would be really hard to execute on, though once I'm in a place to seriously consider it, I'll probably end up learning a lot more.