#332 The Tax Bill Your Friend Isn’t Planning For (And Neither Are You) ft. Peter Kim, MD
In this episode, Peter walks through a phone call with a friend who was about to sell a short-term rental and had never once thought about depreciation recapture, a bill that turned out to be bigger and more complicated than expected. He breaks down exactly how recapture is calculated, the part almost nobody catches involving furniture and appliances, and the real options for deferring or offsetting that tax hit.
If you’ve used aggressive depreciation to lower your taxes now, this episode is about the bill waiting for you later. Tune in!
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Episode Highlights
Now, let’s look at what we discussed in this episode:
- A Question His Friend Couldn’t Answer
- What Depreciation Recapture Actually Means
- The Part Almost Nobody Catches
- Why This Hits Short-Term Rental Investors Hardest
- What to Actually Do About It
Here’s a breakdown of how this episode unfolds.
Episode Breakdown
A Question His Friend Couldn’t Answer
Peter opens with a phone call from a friend who was getting ready to sell his short-term rental, a high end property he bought for $1.8 million and put another couple hundred thousand into renovating. In the middle of the conversation, Peter asked almost in passing what his friend’s plan was for depreciation recapture. The answer was silence, his friend hadn’t thought about it at all.
Peter bets that a good chunk of listeners planning to sell properties are in the exact same position. That gap is what this episode sets out to close.
Before getting into it, he gives his usual disclaimer that everything he’s sharing is based on what he’s seen and done personally, not tax advice for anyone’s specific situation, and that every deal, basis, and state is different enough to require an actual CPA conversation.
What Depreciation Recapture Actually Means
Peter breaks down depreciation as more of a loan from the IRS than a gift. Using his friend’s numbers, he walks through how the property, bought for $1.8 million with $300,000 in renovations, totals about $2.1 million all in. A cost segregation study identified roughly $500,000 of that as eligible for accelerated bonus depreciation, meaning his friend could write most of it off within the first year or two.
He explains that once you deduct that $500,000, it doesn’t just disappear, it lowers your basis, which is what the IRS considers your remaining investment in the property. So instead of a $2.1 million basis, his friend’s basis drops to $1.6 million. When the property sells for $2.6 million, the gain isn’t calculated against the original $2.1 million, it’s calculated against that lower $1.6 million basis, creating a bigger gain than most people expect.
That $500,000 already depreciated becomes exactly the piece that comes back as recapture, while the remaining gain gets taxed at normal capital gains rates. Most people assume depreciation recapture is capped at 25%, and for the building itself, Peter confirms that’s true.
The Part Almost Nobody Catches
Peter gets into the detail that trips most people up. A chunk of that $500,000 in depreciation wasn’t the building itself, it was furniture, appliances, and everything that comes with furnishing a short-term rental. That portion doesn’t get the 25% cap at all, it comes back as regular income taxed at whatever the person’s normal rate happens to be.
He walks through how this changes the math for his friend, pushing what should have been a clean $125,000 recapture bill closer to $140,000, not a massive jump, but enough that it needs to be accounted for. On top of that, there’s still tax owed on the remaining depreciation and the appreciation gain itself.
Peter is honest that when he actually talked this through with his friend, none of it had been budgeted for. His friend simply hadn’t run these numbers before deciding to sell.
Why This Hits Short-Term Rental Investors Hardest
Peter connects this directly to why so many physicians in his community get into short-term rentals in the first place, the short-term rental loophole. If you materially participate in running the property, the depreciation and losses can directly offset W-2 income, which is exactly the strategy his friend had used. That’s also exactly why his depreciation number was so large to begin with.
He explains that making this loophole worth pursuing usually requires aggressive depreciation through a cost segregation study, which frontloads a big chunk of the property’s value into the first couple of years. The tradeoff is straightforward, a bigger write-off going in means a bigger recapture bill coming out.
Peter’s point here is that the people who used the short-term rental loophole correctly and got real value from it are often the most exposed when they eventually sell. He’s clear this isn’t a flaw in the strategy itself, it’s just a part of the story that rarely gets discussed alongside the deduction.
What to Actually Do About It
Peter lays out the practical steps. First, model the recapture number before accepting an offer to sell, not after, since a CPA can usually run this fairly quickly. Second, know the main deferral options available, including a 1031 exchange to roll proceeds into another property, or the opportunity zone strategy covered in a previous episode.
He also walks through two more nuanced options. One involves investing in a new syndication that same year to offset the gain with fresh losses, though this only works if the income types actually match, meaning active losses can’t necessarily offset gains sitting in a passive bucket. He explains that passive investors who simply wrote checks into a deal usually have a cleaner path here, since a syndication loss and a passive sale gain are both in the same bucket and can offset each other directly.
For someone more active, like his friend, the other option is buying a new property that same year and creating a fresh loss through another cost segregation study, provided they stay actively involved in that new property too. Peter closes by being honest that he didn’t have a magic fix for his friend, the real point of the conversation was simply getting him to run the numbers and go in with eyes wide open. His advice for anyone who’s taken meaningful depreciation is the same, build an exit tax plan before you’re in the middle of an exit, not after.
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