Rental property depreciation recapture: What happens when demolishing a fully depreciated building to construct condos?

This is actually a very interesting tax situation. When you demolish a fully depreciated rental property, you're not triggering depreciation recapture because you're not selling the property - you're just removing the structure. The tax basis of your land stays the same, since land isn't depreciable. However, when you demolish the building, you'll need to write off any remaining undepreciated value of the old structure. Since you mentioned it's fully depreciated, there's likely no loss to recognize there. For the new condos, you'll establish a new cost basis based on your construction costs, and you'll begin a fresh depreciation schedule for the new buildings (27.5 years for residential rental property). The original depreciation recapture concern would only come into play when you eventually sell the property.

I wanted to share my experience with a similar situation. After hours of confusing research and conflicting advice from multiple accountants, I finally found https://taxr.ai which helped me understand my exact situation. I was planning to demolish a fully depreciated small apartment building and was worried about massive tax implications. The tool analyzed my property documents and depreciation history, then explained that demolition itself doesn't trigger recapture - it's only when you sell the property that recapture comes into play. They also helped me understand how to properly allocate costs between land (which keeps its original basis) and the new construction (which gets a new depreciable basis). The clarity I got saved me from making a costly mistake in my redevelopment planning. Worth checking out if you're struggling with the complexities of this kind of situation!

Just wanted to follow up about my experience with taxr.ai after being skeptical in my earlier comment. I decided to try it anyway for my duplex demolition project. I uploaded my depreciation schedules and property documents, and the analysis I got back was incredibly detailed. The tool explained exactly how to handle the basis allocation between land and building, confirmed I wouldn't face recapture at demolition time, and provided guidance on setting up the new depreciation schedule for the townhomes I'm building. Everything was backed with specific tax code references. My accountant was actually impressed with the analysis and said it saved him hours of research. Definitely worth it for complicated real estate tax situations like this.

If you're still confused after all this (I sure was with my similar project), I'd recommend actually talking to an IRS agent directly about your specific situation. After spending weeks trying to get someone on the phone, I used https://claimyr.com to get through to an IRS agent in about 20 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c I was demolishing a fully depreciated office building to build apartments and needed clarity on several tax questions. The IRS agent I spoke with confirmed that demolition itself doesn't trigger recapture tax, but also advised me on how to properly document everything to avoid issues in future audits. They also clarified how to handle partial year depreciation for the new construction. Getting definitive answers directly from the IRS gave me confidence to move forward with my project - much better than relying on varied opinions from different sources.

I need to apologize for my skepticism about Claimyr in my previous comment. After another frustrating week of trying to reach the IRS myself about my own property demolition tax questions, I finally gave in and tried the service. I was connected to an IRS tax specialist within 15 minutes who gave me clear answers about my situation. They confirmed that demolishing my depreciated rental wouldn't trigger recapture, but also warned me about some documentation I'd need to maintain to prove the demolition date and value. They also explained how to handle the partially depreciated appliances and fixtures I was removing before demolition. I'm not someone who typically pays for services I can do myself, but the time saved and clarity gained was absolutely worth it. Considering I was making decisions about a $450k redevelopment project, getting direct IRS guidance was invaluable.

Something nobody's mentioned yet - have you considered a 1031 exchange instead of demolition? If you sell the current property and buy a different one, you could defer all the capital gains and depreciation recapture taxes. Might be cleaner than demolishing and rebuilding, depending on your situation.

Don't forget about the basis of the land! Land doesn't get depreciated, so make sure your original purchase allocation between building and land was reasonable. If you're being audited, the IRS might question an allocation that put too much value on the building and not enough on the land. This is especially important with your demolition plan since you'll continue to use the same land. Make sure you have documentation supporting your original land/building allocation.

Great point about the land/building allocation! This is something I hadn't fully considered but it's crucial for my situation. When I originally purchased the property about 15 years ago, I think I allocated around 75% to the building and 25% to land based on the county assessment at the time. Given that land values have increased significantly in my area since then, I'm now wondering if that original allocation would hold up to IRS scrutiny. The lot is pretty substantial and in a desirable location, which is exactly why I want to develop condos there. Should I be getting a current appraisal to establish what the land/building split should be today? Or does the IRS stick with the original purchase allocation regardless of current market conditions? I definitely don't want to run into the same audit issues that Lucas mentioned - that sounds like a nightmare scenario when you're already invested in a major development project.

One thing I haven't seen mentioned yet is the impact of Section 280B regarding demolition expenses. When you demolish the old building, those demolition costs generally can't be deducted as a current expense - instead, they have to be added to the basis of the land. This means your demolition costs will increase your land basis, which could be beneficial when you eventually sell the entire property since it reduces your overall gain. However, since land isn't depreciable, you won't get any current tax benefit from those demolition expenses. Also, make sure to document everything thoroughly - dates of demolition, costs involved, permits obtained, etc. The IRS likes to see clear paper trails for major property changes like this, especially when depreciation schedules are involved. I've seen situations where poor documentation led to complications years later during audits. The good news is that your new condo construction costs will establish a fresh depreciable basis for the new structures, so you'll start getting depreciation benefits again once the new buildings are placed in service.

As a newcomer to this discussion, I want to thank everyone for the incredibly detailed responses - this is exactly the kind of complex tax situation where getting multiple perspectives is invaluable. One additional consideration I haven't seen mentioned is the potential impact on your local property taxes during the development phase. When you demolish the existing structure, your property assessment will likely change, which could affect your carrying costs during construction. Some jurisdictions reassess immediately upon demolition, while others wait until the new construction is complete. Also, regarding the documentation points that Juan and Natalie raised - you might want to consider having a professional photographer document the condition of the existing structure before demolition. This can help support the position that the building had little to no remaining value, especially if you're ever questioned about why it was demolished rather than renovated. The consensus here seems clear that demolition itself won't trigger depreciation recapture, but the devil is really in the details with proper documentation and basis allocation. Given the complexity and the significant investment you're making, having professional guidance from both a tax advisor and possibly a real estate attorney familiar with development projects could be worth the cost for peace of mind.

This has been an incredibly thorough discussion! As someone who went through a similar demolition/rebuild project last year, I want to emphasize something that hasn't been fully stressed: the timing of when you place your new condos "in service" for tax purposes. The IRS considers rental property placed in service when it's ready and available for rent, not when construction is complete. This means if you finish construction in November but don't have your first tenant until February, your depreciation for the new buildings starts in February. This timing can significantly impact your first-year depreciation deduction, especially with the mid-month convention rules. Also, don't overlook the potential for bonus depreciation on certain components of your new construction. While the building structure itself follows the standard 27.5-year schedule, items like appliances, carpeting, and some other personal property components may qualify for accelerated depreciation or even immediate expensing under Section 179. One final tip: consider having your CPA help you set up a separate depreciation schedule for each condo unit if you plan to sell them individually later. This makes the accounting much cleaner if you decide to convert from rental to sale partway through the project. The extra bookkeeping complexity upfront can save significant headaches down the road. The consensus here is absolutely right - demolition won't trigger recapture, but the devil is in the details for everything that comes after!