By Dr. James M. Dahle, WCI Founder
Mitt Romney took a lot of flack in the last election because his tax bill was only 14.1% of his income (despite the fact that he paid millions of dollars in taxes.) I took a look at that and thought “Heck, he's paying way more than the vast majority of Americans, both in terms of dollars and percentage of earnings.” Of course, he probably ISN'T paying a higher percentage than most physicians. In my opinion, most doctors pay way too much in taxes. It's unavoidable for some, but many doctors pay too much simply because they don't understand the tax code.
Some of the more interesting emails I've had in the last year have been from people who couldn't believe that I only paid 8% of my income in federal taxes last year. That surprised me, since it was the highest percentage I had ever paid up until that point in my life. It turns out that lots of docs are paying 20-30% of their income in taxes. Since I made partner halfway through the year and thus have higher income, my percentage is higher this year than last, and will be even higher for 2013, especially with the recent tax increases. But my effective tax rate is still far below my marginal tax rate.
I have to confess, I actually kind of like doing my taxes. It's like a game, me versus the IRS, and my sisters will tell you I've always been a little on the competitive side. The IRS tries to make the rules really complicated, and I try to pay the least that I legally can. I'm not into tax evasion, but I'm certainly not going to leave the IRS a tip.
My Tax Bill
After recently completing my taxes, I added up the damage. Now it's important when you do this that you understand the difference between paying taxes and having money withheld for taxes. These two amounts aren't necessarily the same. I care little how much is withheld (or paid in quarterly estimated taxes), I just care how much I actually end up paying when all is said and done. The other thing that is important when figuring out what percentage of your income you're paying in taxes is what number you're using for income. Since the way you reduce your tax bill is by reducing your taxable income without reducing your gross income (who wants to do that?), nobody cares so much what percentage of your taxable income is paid in taxes. So I use my gross income.
Mitt Romney Paid 14.1% of his income in federal and payroll taxes in 2011
For 2012, on more income than the average physician makes, I ended up paying 9.0% of my income in federal tax, just 3.6% in payroll tax (thanks to my employer paying most of my SS tax), and 2.9% in state tax for a grand total of 15.5%. That's actually a slightly lower percentage than my overall total last year.
Now, to be fair, I really probably ought to adjust that gross income denominator a bit. Let's reduce it by the expenses on my rental property (I was actually able to erase all income from that source) and my malpractice insurance and worker's compensation premiums. That would increase my taxes to 9.8% federal, 3.9% payroll, and 3.1% (state) for a total of 16.8%.
10 Reasons I Pay Less Tax Than Mitt (and Most Doctors)
How is it that I pay 16.8% in taxes when many doctors are paying 25%, 30%, or even 40% in taxes? In short, I do the things that Uncle Sam subsidizes.
#1 I Got Married (and to a Stay-at-Home Mom)
Married couples pay at a much lower rate than a single taxpayer. For example, at $200K of taxable income, the marginal rate for a married taxpayer is 28%, but it is 33% for a single taxpayer. Believe it or not, I managed to stay in the (much larger) married 25% bracket for 2012. Plus, I got an exemption of $3800 for her. All told, I'd be paying another $7K just in federal tax if I were single. The fact that only one of us is working also means we're only paying one set of Social Security taxes.
#2 I Have Kids
Each of them is worth a $3,800 exemption. All together, they saved me over $3K this year in tax. Too bad they cost me a lot more than that.
#3 I Save for Retirement
By maxing out my 401K/profit-sharing plan and my defined benefit plan I reduced my taxable income by $65,000, saving me about $20K in state and federal taxes. This is easily my biggest tax break.
#4 I Pay for Health Care
By maxing out an H.S.A. I get a $6250 deduction. I also get to deduct the health insurance premiums I paid, another $4K+. Between the two of them, I reduced my tax bill by over $3K.
#5 I Own a Business
That allows me to deduct all kinds of expenses, many of which I'd have whether I had the business or not- like internet service, a cell phone, and a computer. Those deductions reduced my federal, payroll, and state taxes by over $1K.
#6 I Own Rental Property
I collected almost $13K in rent for it in 2012. None of it was taxable. Between expenses and depreciation, the IRS thinks I took a loss on the place. But when you include appreciation and the paydown of my mortgage, it was actually somewhat profitable. But I don't have to pay taxes on any of it. If I didn't have such a high income I'd be able to offset some of my other income with that loss, but unfortunately I'll have to wait until I sell to capture that.
#7 I Own the House I Live In
I paid $14K in taxes and interest on it. That reduces my tax bill by over $4K.
#8 I Give Money to Charity
That reduced my tax bill by about $7K.
#9 I Invest in Retirement Accounts
2012 was a pretty good year for my investments. They are almost entirely inside of tax-protected retirement accounts like 401Ks and Roth IRAs. I made about $47K with my investments (not included in the gross income figures that I used to calculate my tax percentages incidentally), almost none of which was taxable.
#10 I Save for College
This didn't reduce my federal taxes (although the gains in the account are federal tax free), but I saved over $500 on my state taxes by contributing to three 529 accounts.
There you go- 10 reasons why I pay a lower percentage in taxes than Mitt Romney.
What percentage are you paying in taxes? What have you done (or plan to do) to reduce that percentage?
I do the same things you do… I have three kids, a mortgage, a wife, 51k to the 401, charitable giving… Just sat down with my tax guy as well. 25%. How’s that you say? AMT. I’m not complaining, having a big tax bill is better than not, but, its still no where near single digits. I didn’t realize any investment income other than some dividends n 2012. High W2 income leads to high federal income taxes…
I’m not really understanding the difference between #3 and #9. Would you mind explaining? If you are saving in retirement accounts that are tax-deferred aren’t you investing in retirement accounts? Thanks
# 3 refers to the tax break for putting money in retirement accounts. # 9 refers to the ongoing tax protection those investments receive. So I knocked something like $90K off my tax bill this year by using retirement accounts. But if you’ve already got a couple of million in a retirement account, and that kicks out $50K in income, you don’t have to pay taxes on that income this year either. So you may save another $20K in taxes there.
Family doctor. Married to stay at home mom, 1 child. Own home. Only 401K this year. Relatively low pay due to one month unemployment and 8 months federal employment (sans bonus…). Tax rate of 7.07%.
Next year we will have another child but also about 40K more in taxable income I suppose without any major changes. Hope it stays under 12% or so. Hopefully when I get out of debt I can add to the retirement and improve that.
I definitely pay over 20% taxes (especially if you include sales tax into the equation).
Of your rules I follow:
1) i got married – yup – to a teacher.
2) kids, nope. But like you said, in terms of net Expected Value and in terms of dollars and cents ONLY i’d rather have no kid than the deduction.
3) I save for retirement. Yes – except I can only get $40K in pre-tax rather than the 65 you do. Nice work!
4) Pay for health care – yes. Exactly the same numbers as you.
5) own a business – no
6) rental property – no
7) own a home – yes
8) charity – this is irrelevant. In my opinion you should consider this as part of the % of your tax bill. I’m pro-charity and think it’s wonderful, but there’s no difference in terms of dollars and cents between giving to charity and paying taxes. At the end of the day the result is still the same, you don’t have the money anymore.
9) Invest in retirement accounts – yup
10) save for college – yup – since i’m trying to conceive a child and am fairly certain i’ll be successful soon, i’ve been contributing for a few years now to a 529 in my name that i’ll transfer over to my child’s name later on.
I used to be obsessed over trimming my tax bill.
Now I really don’t care. I just do what I can to play within the rules and minimize taxes, but in the overall scheme of things I know that if i paid taxes on some sort of income, I made money.. and that’s a good problem to have.
Agree on the charity bit.
From a tax perspective all giving to charity does is take from the Government to give to a “charity” of your choice. Its a questionable allowance as well given that the government may (although may not as well) make better use of some funds that some “charitable” contributions due (say 150 million to a school to build a stadium).
Where charity does help is with non-monetary donations (i.e. – Good will)
I’m surprised to see you equate a mandatory donation to foreign aid, the F-35 program, bridges to nowhere, and bureaucracy with giving to a cause you actually support. Monetarily, of course, it is equivalent, but one I try to minimize and the other I try to maximize. The non-monetary donations are great, of course, but usually don’t add up to much. There are precious few tax breaks that aren’t either money you spend on something else (charity, mortgage interest) or just deferral of tax hopefully to a lower rate (401K etc). One of my favorites is depreciation of a rental property. It basically turns a big chunk of your rent into tax-free income.
At any rate, while you may or may not agree that a charitable deduction is good policy, it’s certainly completely legal and if donating to charity is important to you, you might as well get a tax break instead.
Oh I agree. Donating is good. But from a government standpoint is poor policy for them. Especially considering where a lot of charitable contributions aren’t actually helping “mankind”. A good read at the Atlantic last week: http://www.theatlantic.com/magazine/archive/2013/04/why-the-rich-dont-give/309254/?fb_action_ids=10152670586155504&fb_action_types=og.recommends&fb_source=aggregation&fb_aggregation_id=288381481237582
I am in a very similiar situation (four kids, max out everything, rental prop, etc) as you with one major exception. I am married to a physician who has the nerve to want to work (albeit part time). Our effective rate is 30%. Talk about equal pay for equal work – working women take a major tax hit. Add in the need for child care while their greedy parents work- and oh by the way, if you want in home childcare you have to pick up their SS and pay more tax. Unless you want to be Tim Geitner (substitue your favorite appointee tax deadbeat- I like TG as he is so brillant but yet did not know he had to pay ss taxes) and just play dumb about the whole thing.
I seem bitter – maybe a little, but for people to talk about fair share and target us as deadbeats is just silly. Almost as much as saying Romney did not pay enough.
Next year thanks to BO we will pay even more since 30% is not our fair share! I would prefer a simple “thank you” and maybe pictures of the federal worker or even the old guy(s) we are supporting.
Being married to a doctor is a lousy idea tax wise, but a great idea income wise!
A two-physician couple should make darn sure they’re maxing out retirement account options, which should be doable given the much higher disposable income.
White Coat, quick question. I’ve been reading for a month or so and working through the back log. I noticed your post about the costs of having your wife working and I was wondering if you had any advice for a two physician couple (don’t know if it would be worth a post or just a comment). My fiancee (very soon to be wife!) and I are about to finish our first year in medical school together. Are there any special considerations you would suggest for a couple that will be? I know gross income won’t be a concern, but with such a high marginal tax rate, and such a large amount of debt it’s a little staggering right now.
Big hole but two nice big shovels. It’s the same game as a doctor that makes twice as much as you and has twice as much debt. You pay down your debts, set aside 20% of your income for retirement, try to max out retirement plans etc. The only real difference is that there is a good chance one of you will want to at least go part time when the kids come along, so it’s really important not to grow into the combined income.
Beware that for high income earners who get married, that you may be subject to the “marriage penalty” which bumps you up into a much higher tax bracket. This is especially true if you make around the same amount of money. Definitely worth a google search and some light reading. I just got married to another physician and we made roughly the same amount of money last year…. we just got hit with an unexpected tax bill of ~14k because of nothing else than getting married!
There are both marriage penalties and benefits. You see more penalties when both are earning similar incomes.
Just over 40% effective tax rate including state, federal, payroll, property taxes.
I don’t think you included property taxes in your analysis.
Don’t own my own business, don’t own rental property, like in high tax / high price real estat state state – result being large AMT, high property taxes.
Also have a 15 yr mortgage with not much interest this point.
Oh, and a fairly high income 🙂
The tax codes progressiveness is fine by me, despite the fact that your earlier tax posts seem to ignore basic Econ 101 (you know – the part where the marginal utility of the millionth dollar is quite a bit less than the 20000th – but I digress). What is bothersome is that it’s progressively is arbitrary and leaves obvious loopholes like carried interest, ones you mentioned, etc.
A true AMT would be better, but not in a world where being my brothers keeper has gone out the window.
I’m lucky to owe the taxes I do.
No, I didn’t add in property taxes nor sales taxes nor registration fees on my cars etc.
You’re right that some states punish you far more than others between taxes, cost of living and even Medicaid reimbursement. You’re also right about the marginal utility of wealth. In fact, studies show that more money doesn’t make you any happier, at least after about $75K a year. I also agree that just switching everything to the AMT would be a great simplification of the tax code.
There are also really two categories of physicians with very different financial needs. A family doc with a gross income of $150K or a military doc making $120K just has very different financial needs than a subspecialist or a two physician couple pulling in $800K. One is quite definitely middle class, while the other has much more significant tax, asset protection, and estate planning issues to deal with.
Anyone has suggestions for a good Defined Benefit Plan provider?
We use MedAmerica. They charge a 0.6% fee in addition to fund ERs. Ours is set up to return 0-6.5% a year.
I can’t say they’re any better than anyone else though.
23%. WCI, I remain surprised that yours is still so low–but I’m also surprised you didn’t have AGI above the 25% bracket.
I understand marginal utility. But how about the marginal pain of seeing your 24th patient at 3am at the end of a long shift? Can you argue that you should be paid fully for the first patient and receive 39% less for that last one? Or perhaps it’s ok to be fully paid for your shifts in January, but 39% less for that string of shifts over Christmas vacation and working (and recovering after night shifts) while your children celebrate the holiday without you?
Yeah, I’m happy to qualify for the highest tax bracket, but I do not appreciate being penalized for working hard. I’d recommend everyone read the FairTax Book before bashing the idea of a consumption tax.
I won’t be 25% this year, but probably will still be able to get down to the 28% I suspect, assuming I can continue to avoid AMT.
We don’t have the business expenses and rental property but my wife (she’s the physician) and I do everything else on your list.
There is another big one for families with kids under age 13 that you don’t mention and that is using a cafeteria plan for dependent care. If your wife is a stay-home mom then you don’t qualify but if both parents work you can put up to $5,000 into a pre-tax flexible spending account for dependent care. We use our dependent care cafeteria plan to pay for the after school programs for our two elementary age kids and we also use it to pay for all of their summer camp activities. People might not know this but summer day camps are considered qualified expenses (overnight camps are not). So soccer camp, zoo camp, engineers camp, surfing camp, music camp and all the other “camps” our kids do over the summer are paid for tax free and get charged against our cafeteria plan.
Since you are contributing to an HSA you are ineligible to open a medical flexible savings account (you can do one or the other but not both). But as long as you have a working spouse and kids under 13 you can pay for all their daycare, after school care, and summer camps tax free with a flexible spending account.
How much does the 2nd spouse have to work? Would a 20 hour a week job qualify?
Beau, I take advantage of the dependent care FSA (I also work PT) and I don’t see anything in IRS Pub 503 that says you need to work a minimum number of hours to claim the credit. See page 3 of http://www.irs.gov/pub/irs-pdf/p503.pdf
I don’t think it’s fair to count investment income in your calculations. Most tax percentage analysis doesn’t. That income is only realized when you sell. It’s like counting the appreciation in your home before you go and sell it. Yes, it’s real money on paper, but it’s not exactly income in that tax year.
You know I didn’t, right? I didn’t make that entirely clear above.
My husband is about half way through his residency and I’m a Postdoc. We paid a total of 7.10% in Federal taxes this year (also our highest yet) and state and social security brings that total to 13.1%.
I’m trying to learn more about building wealth and minimizing taxes before my husband finishes his residency. I found the book ‘Tax Insight’ to be very helpful for learning more about taxes. Your blog is one of my go to sources for learning about building wealth as a physician (and protecting it through insurance I didn’t even know we should have!), so thank you for such a great resource!
Great post. I have a rental home too. Do you do your own depreciation calculations and if so, how?
Value of property/27.5. The only thing complicated is that you can add some things to the value of the property the first year you put it into rental service.
I thought you could only depreciate the value of the improvements, not the entire property value including land…can you clarify?
That’s correct, you only get to depreciate the building, not the land. The easiest way to do that is the tax assessment. If the tax assessment says 80% of the value of the property is the building, and the property is worth $150K, then you depreciate $120K+ the value of any improvements.
Thanks for the (always) helpful post. Could you expand a bit on different ways to maximize money into pretax retirement accounts, particularly for those with W2? I’ve read posts mentioning anywhere from 51k to your 65k, and I was wondering how one gets to those numbers beyond the standard 17,500 to the 401k.
– 401k/403b (17,500), 457 (17,500), plus employer contribution
– For those that are 1099, employee deferrals + employer/profit sharing up to 51k
– How does the DBP work and what are the maximums?
Also 6500 into HSA.
Remember this when people talk about how nice it is to just be an employee and get paid on a W-2. It has it’s downsides, like only being able to put $17.5K into a 401K and not being able to use an HSA. There are definitely more tax breaks to being self-employed. Of course, you get to pay both halves of payroll taxes too, which kind of sucks. A defined benefit plan also has to be set up by the employer and maximums vary due to actuarial reasons. Ours are limited to $15K, but used to be $35K. I’m no actuary, but it has to do with how many partners there are, how much people are contributing, how old they are etc.
You can’t use an HSA if you get paid on a W-2? My husband gets paid on a W-2, and he contributes to an HSA. I thought you just had to have a qualified health plan to be eligible to contribute to an HSA.
You’re correct, I made an error. If you have a high deductible plan, you qualify for an HSA whether you are paid on a W-2 or a 1099. Many employees, however, are not offered the option of a high deductible plan and get whatever the company is offering.
I’m not a doctor, but I love this site. Great job with with your taxes! I too like doing my taxes, but I’m not sure if i’m doing a good job. I only have 3,5,7,9 on your list. So I contribute to a retirement accounts, own my condo, have a business on top of my full time job, and have a roth ira. My overall tax ended up at 18.5% federal and 7% state in California.
Do you think it’s worth it to get a professional accountant to do your taxes or do you just do them yourself with turbo tax? I’m assuming self filing since you seem very competent. In that case do you pay for the turbo tax upgrades?
I just use deluxe Turbotax and skip the upgrades.
Hi,
I have a hard time getting Turbo Tax to do the Backdoor Roth. When I enter info that I converted Traditional to Roth IRA, it always calculates the Tax on Traditional IRA distribution (It doesn’t realize that my Traditional IRA contribution is post tax)
Any advice.
Thanks
I’d do the post myself, but it’s already been done:
http://thefinancebuff.com/how-to-report-backdoor-roth-in-turbotax.html
Thank you. I think your blog is the best one out there
You’re welcome.
Great article, would you mind considering a post along similar lines for us physicians who are employed and get a W2?
Love your site and this post, thanks again.
Taxes are pretty simple as a W-2 employee, but 7 of the 10 options above are available to you. It’s not like you can’t start a side business doing something else or buy rental property.
I do taxes on my own as well (free Turbotax edition). Because I just started residency, and file married with a child my tax rate (as written on front page of report by Turbotax) was -2.54%.
I also read how much people get charged by places like H&R block for personal taxes; some pay up to $500 to get them done. In todays age that should not be happening.
When I worked I took the standard deduction and had no children to claim and still paid less than Romney. I maxed my 401K which was the reason.
im not sure focusing on the effective tax rate number is of value. As mentioned, you can pseudo get that number down by donating but that isnt actually helpful in obtaining more wealth. You can do the items above when/if they apply to you and whatever number you have after that is what you got. Allowing taxes to lead the train can lead you into bad decisions.
Yes, you need to be careful to avoid letting the tax tail wag the income/investment dog. The goal isn’t to minimize the tax bill, but to maximize the after-tax income and the good you can do with it (whether that is paying for your own retirement, funding your kid’s college, or donating to causes you support.)
Planning to do many of these but had a question. Is there a greater ability to put more money in retirement accounts if you work for a Group vs. a hospital like Kaiser? We live in CA, I make 100K+ and max my retirement plans each year, but my wife, the ER doc out of residency in 1yr and 3 months, is about to start her medical career at 40 years old with no retirement savings to date. So as she starts to look at Groups vs. Kaiser I was wondering if retirement saving options are all equal?
I don’t know the Kaiser retirement plan, but retirement options definitely vary highly from group to group and employer to employer. Most private groups usually at least have a profit sharing plan ($51K a year) and possibly also a defined benefit plan. Many employees don’t have access to anything more than a 401K ($17.5K). Worth checking in to when interviewing for jobs.
From my understanding, each Kaiser location’s retirement benefits get tweaked a bit, but here’s one I saw a year ago:
1. A very healthy defined benefit plan (50% of the highest three years annualized, requires 30 years service (or it gets scaled back a bit))
2. A money purchase pension plan (5% contribution below the social security wage base of $113,700) + 10% contribution up to the IRS annual compensation limit ($255,000 in 2013)
3. A voluntary 401(k)
Additionally, they pay the entire cost of health, long-term care, dental, vision for physician and family. Needless to say, their benefits are becoming more of a rarity for W-2 employees.
Good to see someone still looks out for their employees.
Yet another great and insightful post, hats off WCI!
I see you’re still contributing to Roth IRA. Rookie question, but isn’t there a limit to contributing to that, even if filing jointly, isn’t there an income cap of ~180?
Thanks
The key is to contribute “through the back door”:
https://www.whitecoatinvestor.com/retirement-accounts/backdoor-roth-ira/
Really great post — Thanks!
So to confirm, it seems like an accurate “gross income” should include any employer “match” money?
even doing so, I pay 25.5% (18.3% fed income, 4.4% state, 2.8% payroll).
big hit from AMT (high property tax area, high state inc tax)
married, wife is a stay-at-home, 2 kids, 20k in home taxes/interest, +charity BUT no HSA, no business, no rental income and no state 529 tax savings AND as employee, only have access to 403b (which I have as a Roth) and a 457 (pre-tax) (so only 17K last yr). Probably should change the Roth 403b to a regular 403b to increase to 35k pretax contrib/year… although conversely was doing the 403b as a Roth to “tax diversify” in lieu of “backdooring” our trad IRA’s… thoughts? perhaps more advantages with doing backdoor Roth IRA’s than Roth 403b in terms of mandatory withdrawals, estate planning, etc., right?
If I were paying 18% of my income in federal taxes and 4.4% in state taxes that seems to imply a pretty high marginal rate. I’d be doing all tax-deferred money in the retirement plan, especially since you have backdoor Roths on the side for tax diversification.
There’s no standard formula for calculating gross income, but it seems reasonable to me to include the employer match. I’ve never had a job that had a match, so I’ve never personally had to deal with that issue.
Thanks. Makes sense.
By the way, do you usually contribute to a non-deductible trad IRA and then do the backdoor conversion as one lump sum once per year? I have been contributing monthly (automated) to our trad IRA but it would seem impractical to then do immediate Roth conversions many times per year…
Exactly. That’s why I lump sum it. Some years I’ve had the cash to do it the first week of January. Didn’t have it until March this year.
A little bit of knowledge……
Perhaps you never heard of the marriage tax penalty? The ONLY reason you think you pay less in taxes as a married individual is because your spouse earns zero and you claim an exemption for your spouse. Even here, you are wrong — if your spouse made zero but wasn’t married to you, (s)he would qualify for all kinds of “free” stuff from the government.
http://en.wikipedia.org/wiki/Marriage_penalty
Also, I hate to break it to you, but your tax bill is going to shock you if you ever sell your rental property. Far from taking some of the “loss” and deducting it from your taxes, you are going to see a huge taxable gain. Let’s say you paid $100,000 for the property and you hold it until it is fully depreciated, then sell it for $150,000. How much is taxable income ? All $150,000. (some will be ordinary income and some might be taxed at a favorable capital gains rate) The only way to avoid this is to move in to the property for a certain period of time and use it as a personal residence, and then it gets very tricky. Trust me, anything you depreciate on your taxes — the government wants a cut of that money if the asset turns out to still be salable. I have learned this the hard way, and so will you. I urge you to talk to your accountant.
The major benefit from being married isn’t the exemption, it’s the different brackets. If your taxable income is $40K and you’re married, you’re in the 15% bracket. If you’re single, you’re in the 25% bracket. But no, I never considered all those great welfare benefits we’re missing out on like food stamps and medicaid. Maybe I should go look for that divorce paperwork…… 🙂
Again, you are blogging to the masses, and using a very specific example that doesn’t fit the masses. The marriage penalty has been greatly reduced, but still exists.
Lets take 2 docs in a specialty that pays 180k each. What bracket are they in? Single : each is in the 28% bracket….. married filing jointly they are in the 33% bracket. (using 2013 brackets for taxes dues April 15, 2014).
{Cases like these need to see if married filing separately makes sense. A pretty easy calculation for most tax software.}
I agree there are lots of quirks in the tax code and every married taxpayer should run the numbers both ways before deciding to file jointly or separately.
Your forbearance is extraordinary, WCI…just saying. 😉
Here is one article about “depreciation recapture”. See, for most people, taking depreciation makes sense because they are already paying in at much more than the 25% rate. (which was the rate of Depreciation recapture the last time I checked the IRS rules) But you claim to have a marginal rate of about 8%. So you, my friend, are gonna get stung very badly if you sell your rental property at a price above it’s depreciated value.
http://homeguides.sfgate.com/tax-implications-not-charging-depreciation-rental-property-41748.html
Here are the salient points from the article:
Depreciation Recapture
Since depreciation is supposed to simulate your building losing value over time, what happens if you sell your rental property for more than the depreciated value? The IRS sees this and, in essence, says: “Wait a minute. You got me to reduce your taxes by telling me your building was losing value. And it didn’t. Where’s my money?” To get back the depreciation that you claimed, the IRS recaptures that accumulated depreciation at a 25 percent tax rate. In other words, if you buy a property for $400,000, claim $100,000 in depreciation and sell it for $450,000, you’ll have a $50,000 capital gain, and $100,000 that is subject to Section 1250 depreciation recapture.
Why Eschewing Depreciation is a Mistake
You might be tempted to avoid the risk of getting hit with recapture tax and to not claim depreciation. This would be a gigantic mistake. First of all, if you own investment property, you probably pay tax at a rate of 25 percent or more, so paying 25 percent recapture tax still saves you money. Plus, by claiming depreciation, you get money today that you can use and invest, even if you have to pay taxes on it in the future. The real reason to claim depreciation is that the IRS will charge you recapture tax as if you depreciated your property, whether or not you actually did. Since you’re going to pay the bill in the future, you might as well get the benefit today.
Sorry about the mistake in my first reply about calling some of the sale price of rental property “ordinary income”…. that only applies to most non-real-property assets (like boats or airplanes or hot dog stands you rent out that are depreciated).
The correct term for what you are up against in the future is in my second reply: Depreciation recapture (section 1250).
I’m looking forward to paying taxes on gains from that house. I hope there are some to pay taxes on. Even with depreciation recapture, I’ve still got several years of depreciation I can take without ever having to pay taxes on it thanks to losses and transaction costs.
The other easy way to avoid those recapture taxes is to 1031 exchange into another property, deferring the taxes even further. Eventually this becomes an estate planning situation as the kids inherit at a higher basis but with death tax.
Do you know whether you can use depreciation from one rental proprty to offset the depreciation recapture from the sale of another?
Generally yes, but the question is whether the fact that you can’t claim passive losses if you have a typical doctor income will affect the situation. I think that since the depreciation recapture is a passive loss and the depreciation from the other property is also passive would allow you to offset.