How Is Capital Gains Calculated on Sale of Rental Property?
Investing in rental properties can be a lucrative endeavor, but it’s important to understand the tax implications when selling such properties. The sale of a rental property can trigger capital gains tax, which is the tax on the profit made from the sale. Capital gains tax is calculated differently than regular income tax, so it’s important to know the rules and regulations surrounding it. In this article, we will discuss how capital gains are calculated on the sale of a rental property and answer some frequently asked questions.
Capital gains on the sale of a rental property are determined by subtracting the property’s adjusted basis from the sale price. The adjusted basis is the original purchase price of the property plus any improvements or additions made over the years, minus any depreciation claimed. The resulting figure is the property’s cost basis, which is used to calculate the capital gains.
To calculate the capital gains, subtract the cost basis from the sale price. If the resulting figure is positive, it represents a capital gain. If it is negative, it represents a capital loss. Capital gains are then subject to taxation at different rates depending on the holding period and the taxpayer’s income level.
There are two types of capital gains tax rates: short-term and long-term. Short-term capital gains are taxed at the taxpayer’s ordinary income tax rate, while long-term capital gains are taxed at a lower rate. The distinction between short-term and long-term depends on how long the property was held before it was sold.
If the property was held for one year or less, it is considered a short-term capital gain and is subject to the ordinary income tax rate. However, if the property was held for more than one year, it is considered a long-term capital gain, and the tax rate depends on the taxpayer’s income level. For most taxpayers, the long-term capital gains tax rate is 15%, but it can be as high as 20% for high-income earners.
Now, let’s address some commonly asked questions regarding the calculation of capital gains on the sale of rental property:
1. Do I have to pay capital gains tax when selling a rental property?
Yes, the profit made from the sale of a rental property is subject to capital gains tax.
2. How is the adjusted basis calculated?
The adjusted basis is calculated by adding the original purchase price and the cost of any improvements, minus any depreciation claimed.
3. Can I deduct selling expenses from the sale price?
Yes, certain selling expenses, such as real estate agent commissions and advertising costs, can be deducted from the sale price to determine the taxable capital gains.
4. Can I defer capital gains tax when selling a rental property?
Yes, through a 1031 exchange, you can defer capital gains tax by reinvesting the proceeds from the sale into another investment property.
5. What if I sell my rental property at a loss?
If the sale of your rental property results in a capital loss, you may be able to deduct it from your other taxable income, subject to certain limitations.
6. Are there any exemptions to capital gains tax when selling a rental property?
Yes, if the rental property was your primary residence for at least two out of the last five years, you may be eligible for a capital gains exclusion of up to $250,000 for individuals and $500,000 for married couples filing jointly.
7. Can I deduct depreciation recapture from the capital gains?
Yes, when calculating the capital gains, you must include any depreciation recapture as part of the adjusted basis.
8. What if I have taken Section 179 deductions on the property?
Section 179 deductions reduce your basis in the property. When calculating the adjusted basis, you must subtract any Section 179 deductions claimed.
9. Can I use the cost basis of the property from many years ago?
No, you must use the adjusted basis, which includes the original purchase price, improvements, and depreciation claimed.
10. Do I have to pay state taxes on the capital gains from selling a rental property?
Capital gains tax is usually subject to both federal and state taxation. The state tax rate varies depending on the jurisdiction.
11. Are there any tax benefits for reinvesting capital gains from a rental property sale?
Through a 1031 exchange, you can defer capital gains tax by reinvesting the proceeds into another investment property.
12. What if I inherited the rental property and want to sell it?
If you inherited a rental property, the cost basis is generally the fair market value of the property on the date of the deceased owner’s death. You can use this value to calculate the capital gains when you sell the property.
Understanding how capital gains are calculated on the sale of a rental property is crucial for making informed financial decisions. It is advisable to consult with a tax professional or accountant to ensure compliance with the ever-changing tax laws and regulations.
