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URL:  https://boards.fool.com/peter-this-is-the-best-explanation-so-far-i-have-26473591.aspx

Subject:  Re: rental property depreciation recapture Date:  3/14/2008  7:07 PM
Author:  ptheland Number:  99474 of 132797

Peter, this is the best explanation so far I have ever researched and found on this subject.

Thank you. There must be better ones out there. Just keep looking.

I understood 97% of your reply,

Wow! I only understood 75% of what I wrote. ;-)

except your sentence at the end: "The capital gain portion is currently taxed at a rate less than your ordinary losses from the passive activities". Can you elaborate a bit or give an example?

Sure.

No matter what your tax bracket, long term capital gains are taxed at a lower rate than ordinary income. (Well, unless you have so little income that you are effectively in the zero percent bracket.) The passive losses you are accumulating - the amounts in excess of $25k per year - are almost certainly ordinary income. When you use them, they reduce your ordinary income and save you tax dollars at your marginal rate.

Long term capital gains are taxed at no more than 15%. The long term capital gains from selling a rental property (assuming that you hold these long enough to actually have a gain on the properties) get this beneficial tax rate. AND that long term capital gain also allows you to use a portion of the deferred passive losses.

So you reduce your ordinary income at the same time you recognize long term capital gain income. If the amounts happened to be equal, that means more of your total income will be taxed at the lower capital gain rate.

Granted, from an overall perspective it would be nice to use those losses now rather than later. But since the tax law prohibits that, you still get to use them, even if it is some time down the road. And when those losses are finally freed up, they're going to help improve your overall tax rate in the year you do get to use them.

So, like I said earlier, just take the depreciation now, accumulate up the losses, and you'll put them to use down the road when you finally sell. When you do that, you'll be better off than you would have been had you not depreciated the property at all.

--Peter
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