The last post on this thread was so long ago that I doubt anyone is reading it any more, but in case someone is, I have a question regarding depreciation and AMT. Depreciation recapture is supposed to be taxed at 25%, but with AMT, I find it?s effectively taxed at a far higher rate, 36%, and I?m trying to find out why.
Here is a simple case to illustrate this point. Suppose you have an income of $400,000, distributed in three different situations:
a) all of it is in capital gains, as from sale of a rental property;
b) $260,000 of it is in CG, the remaining $140,000 is ordinary income;
c) $260,000 of it is in CG, the remaining $140,000 is depreciation recapture.
Using Form 6251 to determine AMT (I also had to fill out the Schedule D Tax Worksheet first, since some of the line amounts there go into Form 6251), I get the following results:
a) The total tax is $54,353 (Form 6251, l. 55). It?s just the total amount (less $37,650, which is basically a deduction that AMT uses) taxed at 15%, the capital gain rate. You wouldn?t need to file 6251 in this case, but I included this example to show how AMT does not tax CG at a higher rate than the standard 15%.
b) The total tax is $75,400, which is the sum of the 15% CG rate applied to $260,000 ($39,000; l. 55) and the 26% AMT rate applied to $140,000 ($36,400; l. 42). The CG is again taxed at 15%, while the ordinary income is subject to a higher rate.
c) The total tax is $89,400, and here is where it gets strange. The $140,000 depreciation is taxed at 26% on l. 42 to give $36,400, just as ordinary income is in b). But rather than the remaining $260,000 in CG taxed at 15%, only the difference between this and depreciation ($120,000) is taxed at this rate (l. 55), to give $18,000. The remaining $140,000 is taxed at 25% (l. 60), to give $35,000.
If depreciation were treated as ordinary income, as in b), all of the $260,000 CG would be taxed at 15%. The fact that a portion of the CG equal in amount to the depreciation is taxed at 25% means that depreciation is in effect taxed at 36%--26% in l. 42, plus the difference between 25% and the CG rate of 15%, 10%, in l. 60.
So what?s going on here? I understand that recaptured depreciation is not treated exactly the same as ordinary income, but how can it be taxed at 36%? I've read a lot of discussions of AMT on the internet, and I?ve never found anyone who was aware of this, though it must be fairly common for individuals selling rental real estate to have a large amount of recaptured depreciation to claim. In fact, this means that in virtually all cases, one will pay more taxes on the recaptured depreciation than one saved in taxes when one took the depreciation, which seems to me rather unfair.
I?ll just add that on the Schedule D Tax Worksheet?which is used to determine the tax when AMT is unnecessary--this distinction between depreciation and ordinary income is also maintained. That is, both depreciation and ordinary income are taxed at the same rate on one line in the worksheet (about 21% up to $100,000, plus 28% for amounts over $100,000), but then an amount equal to the depreciation is taxed again on another line, just as is the case with Form 6251 (and this amount is subtracted from the amount of CG taxed at 15%, also as in Form 6251). The difference is that when depreciation is re-taxed in the worksheet, the rate is 15%. This is the same as the CG rate, so in effect it means it adds no further tax to that already determined in a previous line. |