Can depreciation recapture taxes be avoided by selling the LLC instead of the property?

But what if the LLC has owned the property from the beginning? Would that change anything or does recapture still apply no matter what?

It doesn't matter whether the LLC owned the property from the beginning or not. Depreciation recapture is tied to the property itself, not when or how the ownership was structured. If depreciation deductions were taken (reducing your basis in the property), those will be recaptured as ordinary income when there's a taxable event - whether you sell the property directly or sell the entity that owns it. If the LLC has always owned the property, the depreciation deductions would have passed through to you (the LLC owner) on your personal tax return over the years. So when you sell your interest in the LLC, the portion of your gain related to those previous depreciation deductions will still be subject to recapture.

How exactly does this tool work? Is it just a search engine for tax info or does it actually give personalized advice? I've been using TurboTax but it doesn't really help with strategic questions like this.

I'm skeptical of AI tools for something this complex. Did it actually give you specific strategies that would work for your situation or just general info you could find on Google?

It's more than just a search engine. You can ask specific questions about your tax situation, and it analyzes IRS publications, tax court cases, and other authoritative sources to give you specific answers. It's like having a tax research assistant that can instantly find and explain relevant tax laws. For my real estate question, it found specific IRS rulings about entity sales that I never would have discovered on my own. The tool doesn't just give generic advice - it cites specific tax code sections and explains how they apply to your scenario. When I asked about alternatives to my entity sale idea, it outlined several options with pros and cons for each, including some sophisticated strategies involving installment sales combined with charitable remainder trusts that my regular accountant hadn't considered.

How does this actually work? I don't understand how they can hold your place in line at the IRS. That sounds kind of fishy to me.

I don't buy it. The IRS wait times are a nightmare because their systems are completely overwhelmed. There's no way some third-party service has figured out how to game the system. And even if you do get through, regular IRS phone agents rarely understand complex real estate tax questions.

They use an automated system that basically waits on hold for you. It's not actually "cutting the line" - they're just waiting in it so you don't have to. When an agent picks up, their system connects the call to your phone. It's surprisingly simple once you see how it works. IRS agents vary in their knowledge, but I got lucky with someone who clearly understood real estate issues. She explained that Section 751 of the tax code specifically addresses selling entities that hold depreciated assets, and confirmed that the recapture will follow you regardless of whether you sell the property directly or the entity that owns it. She also pointed me to some IRS publications that cover this topic in detail.

I have thought about 1031, but I'm actually wanting to reduce my real estate holdings, not replace them with other properties. I'm approaching retirement and looking to simplify. Is there any strategy for someone in my position who wants to exit real estate entirely but minimize the tax hit?

In that case, a 1031 exchange probably doesn't make sense for your situation. If you're looking to exit real estate completely, you might want to consider an installment sale. This lets you spread the gain (and the associated tax liability) over multiple years instead of taking the hit all at once. Another option might be investing in a Qualified Opportunity Zone fund with your proceeds, which could defer your capital gains until 2026. However, this doesn't completely eliminate the recapture tax and comes with its own set of requirements and risks.

Can you explain more about how the DST worked for you? I'm in a similar situation and looking to simplify without getting hammered on taxes.

A DST is basically a trust that owns institutional-grade real estate (think large apartment complexes, office buildings, etc.) and you buy fractional interests in it. Since you're technically still investing in real estate, it qualifies for 1031 treatment. The big advantage is you get professional management - no more tenant calls or maintenance headaches. You receive monthly distributions based on your ownership percentage. I exchanged my rental duplex into a DST that owns a portfolio of medical office buildings. Been getting steady 5-6% distributions without any of the landlord responsibilities. The downside is you have very little control - you can't make management decisions like you could with direct ownership. And there are minimum investment amounts, usually $100k+. But for someone looking to simplify while staying in real estate, it's a solid option.

This is really helpful - thank you for breaking down all the legitimate alternatives! I'm particularly interested in the Charitable Remainder Trust option since I was already planning to increase my charitable giving in retirement. How exactly does a CRT work with real estate sales? Do you contribute the property directly to the trust, or do you sell it first and then contribute the proceeds? And what kind of income stream can you typically expect from something like this?

Great question! With a CRT, you typically contribute the property directly to the trust rather than selling it first and contributing cash. This is actually one of the key benefits - when you contribute appreciated property to a CRT, you avoid the immediate capital gains tax (including depreciation recapture) because the CRT is a tax-exempt entity. Here's how it works: You transfer your rental property to the CRT, receive an immediate charitable tax deduction for the present value of the remainder interest, and then the trust sells the property tax-free. The trust uses the full proceeds (no taxes paid) to invest in an income-producing portfolio that pays you a stream of income for life or a specified term. The income stream depends on the type of CRT you choose. A CRAT (Charitable Remainder Annuity Trust) pays a fixed dollar amount annually, while a CRUT (Charitable Remainder Unitrust) pays a percentage of the trust's value each year. Typical payout rates range from 5-8% annually. The downsides are that it's irrevocable (you can't get the property back), there are minimum charitable remainder requirements (usually at least 10% must go to charity), and setup/administration costs can be significant. But for someone with substantial appreciated real estate who's charitably inclined, it can be a powerful strategy to avoid recapture while generating retirement income.

This is exactly the kind of practical advice I needed to hear! The combination approach makes a lot of sense, especially the point about depreciation recapture being capped at 25%. I've been so focused on trying to avoid the taxes entirely that I hadn't really considered strategies to just manage them better. The installment sale option is particularly appealing since it would give me steady income during retirement while spreading out the tax burden. Can I ask - did you structure the installment sales yourself or did you need special legal documentation? And how did you determine the right payment schedule (5 years vs longer)? Also really interested in your DST experience. How has the income been compared to what you were getting from direct ownership? I'm worried about giving up control, but if the returns are decent and I don't have to deal with tenant issues anymore, it might be worth it.

You definitely need proper legal documentation for installment sales - this isn't something to DIY. I worked with a real estate attorney who drafted a promissory note with specific terms including interest rate, payment schedule, and default provisions. The IRS has strict rules about installment sales, especially the imputed interest requirements. For the payment schedule, I chose 5 years because it balanced getting reasonable annual payments with not stretching it out so long that I'd worry about the buyer's ability to pay. Longer terms mean lower annual payments but more risk. I required 20% down payments which helped reduce my risk exposure. Regarding the DST - the income has actually been more consistent than my direct ownership properties, though slightly lower overall yield (about 5.8% vs the 7-8% I was averaging with direct ownership). But when you factor in no vacancy periods, no maintenance costs, no property management headaches, and professional institutional management, it's been worth the trade-off. Plus I'm getting monthly distributions instead of dealing with sporadic rental income and unexpected repair bills. The lack of control was initially hard to accept, but honestly it's been liberating. I sleep better not worrying about midnight emergency calls or difficult tenants. For someone transitioning to retirement, the peace of mind has real value beyond just the financial returns.

This phased approach sounds really smart - spreading sales across tax years to manage the overall burden. I'm curious about the REIT option you mentioned. I thought 1031 exchanges had to be into direct real estate ownership, not REITs. Did you use a specific type of REIT or structure that qualified for like-kind treatment? Also, your point about just taking the hit on properties with minimal appreciation is something I hadn't considered. I've been so focused on the "big picture" tax impact that I haven't really analyzed each property individually. Some of mine probably fall into that category where the complexity of advanced strategies might not be worth it. The timing consideration around retirement tax brackets is particularly relevant for me since I'm planning to retire in about 3 years. I'm currently in the 32% bracket but expect to drop to 22% in retirement. Would it make sense to hold off on sales until then, or does the 25% recapture cap make the bracket difference less important?

You're right to question the REIT option - I misspoke in my earlier comment. Traditional REITs don't qualify for 1031 exchanges. What I actually used was a Delaware Statutory Trust (DST) that invests in a diversified portfolio of commercial properties. DSTs do qualify for like-kind treatment under Section 1031. The DST I chose happens to have a REIT-like structure in terms of professional management and diversification, which is probably why I confused the terminology. But you're absolutely correct that direct REIT investments wouldn't work for a 1031 exchange. Regarding the timing question - you're smart to think about this strategically. Since depreciation recapture is capped at 25% regardless of your ordinary income bracket, the difference between selling now (32% bracket) vs. retirement (22% bracket) mainly affects the capital gains portion above recapture, not the recapture itself. If your properties have significant appreciation beyond the depreciation taken, waiting until retirement could save you 10% on that excess gain. But if most of your gain is from depreciation, the timing won't matter as much tax-wise. You'd need to run the numbers on each property to see where you stand. Also consider that holding for 3 more years means 3 more years of depreciation deductions, which will increase your eventual recapture liability. Sometimes the bird in the hand approach makes more sense, especially if you're ready to simplify your life now rather than managing rentals for another few years.