How to Figure Capital Gains on Rental Property
Investing in rental property can be a lucrative venture, providing a steady stream of income and potential for capital gains. However, when it comes time to sell your rental property, you’ll need to understand how to calculate capital gains in order to properly report them to the IRS. Here is a step-by-step guide on how to figure capital gains on rental property:
Step 1: Determine your cost basis
The cost basis of your rental property is the original purchase price, plus any additional costs such as closing fees, legal fees, and improvements or renovations. This will serve as the starting point for calculating your capital gains.
Step 2: Calculate your adjusted basis
To determine your adjusted basis, you’ll need to subtract any depreciation deductions you’ve taken over the years. Depreciation is the annual deduction you can take for the wear and tear of your rental property. The IRS allows you to depreciate residential rental property over 27.5 years.
Step 3: Determine your selling price
The selling price is the amount you receive from the sale of your rental property. This includes any cash received, as well as the fair market value of any property or services you receive in exchange.
Step 4: Subtract selling expenses
You can deduct certain expenses associated with selling your rental property, such as real estate commissions, legal fees, and advertising costs. Subtract these expenses from the selling price to arrive at your net sales price.
Step 5: Calculate your capital gains
To calculate your capital gains, subtract your adjusted basis from your net sales price. If the result is a positive number, you have a capital gain. If it’s negative, you have a capital loss.
Step 6: Determine your tax rate
The tax rate on capital gains depends on your income level and how long you’ve held the rental property. If you’ve owned the property for more than one year, you’ll be subject to long-term capital gains tax rates, which are generally lower than ordinary income tax rates.
Step 7: Report your capital gains
Report your capital gains on Schedule D of your federal tax return. Be sure to include all necessary information, such as the date of sale, purchase price, selling price, and any expenses or deductions.
FAQs about figuring capital gains on rental property:
1. Do I have to pay capital gains tax if I sell my rental property at a loss?
No, you only pay capital gains tax if you have a capital gain on the sale of your rental property.
2. Can I deduct the cost of renovations from my capital gains?
No, the cost of renovations is added to your cost basis and reduces your capital gains.
3. What if I inherited the rental property?
If you inherited the rental property, your cost basis is generally the fair market value of the property at the time of the previous owner’s death.
4. Can I use the 1031 exchange to defer capital gains tax on the sale of my rental property?
Yes, the 1031 exchange allows you to defer capital gains tax by reinvesting the proceeds from the sale into a like-kind property.
5. How do I calculate depreciation on my rental property?
To calculate depreciation, divide the cost basis of your rental property by 27.5 years. This is the amount you can deduct each year as depreciation.
6. What happens if I sell my rental property for less than my adjusted basis?
If you sell your rental property for less than your adjusted basis, you have a capital loss. This loss can be used to offset other capital gains or deducted against your ordinary income.
7. How can I minimize capital gains tax on the sale of my rental property?
One way to minimize capital gains tax is to hold onto the property for more than one year to qualify for long-term capital gains rates. Additionally, you can take advantage of tax deductions and credits related to rental property expenses.
8. Do I have to pay state taxes on capital gains from rental property?
State tax laws vary, so it’s important to consult with a tax professional or research the specific tax laws in your state.
9. Can I deduct the cost of repairs from my capital gains?
No, the cost of repairs is not deducted from your capital gains. However, it can be deducted as an expense on your rental property.
10. How do I report capital gains from the sale of my rental property if I’m a non-resident alien?
Non-resident aliens are subject to different tax rules. It’s important to consult with a tax professional who specializes in international tax laws.
11. What if I sell my rental property at a loss but made a profit from renting it?
If you sell your rental property at a loss but made a profit from renting it, you can still deduct any losses against your rental income.
12. What if I convert my rental property into my primary residence before selling?
If you convert your rental property into your primary residence and meet certain criteria, you may be able to exclude a portion of the capital gains from the sale under the home sale exclusion rules.
Understanding how to figure capital gains on rental property is essential for any real estate investor. By following these steps and seeking professional advice when needed, you can properly calculate and report your capital gains, ensuring compliance with IRS regulations.
