Monday, January 18, 2010

Don’t Claim Depreciation?? Part I: Allowed or Allowable

“Don’t take depreciation because you will have to have pay tax on it when you sell the property.” I have heard this from many real estate rental property owners and taxpayers claiming the home office deduction. What they don’t realize is that you have to pay tax on the depreciation you could have claimed even if you didn’t claim it. What? Yes! The tax law on this has been around for many years and is very well established. If you doubt it, just look at Line 22 of IRS Form 4797, “Sales of Business Property” (home office and rental real estate are Internal Revenue Code Section 1250 business property for this purpose). The cost basis of the property sold must be decreased (and therefore the gain increased) by the amount of depreciation allowed or allowable, whichever is higher. “Allowed” means what you claimed on your tax returns over the years. “Allowable” means what you could have claimed. Future discussion of this topic expands on this issue, discussing catching up missed depreciation, capital gains and ordinary tax rates, and the time value of money.