Capital Gains Tax on Sale of Rental Property
It all begins with how much depreciation that you've claimed on the rental property. The capital gains actually apply to the difference in the sales amount of the property to the adjusted amount that is remaining through depreciation.
Did You Know That Depreciation Always Happens?
Some landlords might try to not claim depreciation on their rental property in order to get out of paying a capital gains tax on the difference, but that isn't possible. Depreciation happens whether you claim it or not. Even if you haven't taken the deduction for depreciation in 5 years, the recapture amount of the depreciation is going to occur. You might as well file an amended tax return if you can to claim the deduction.
The good news is that you won't have to pay the capital gains tax on the entire sale amount. You'll be able to pay it on the difference instead. Some of the gains that you report on the sale will be taxed as ordinary income and then some of it will be a capital gains tax.
In the United States, there's also a new tax that applies specifically to net investment income. This is a 3.8% tax that applies to that investment income only if your income is more than $125k as an individual filer, $250k if you're married and filing jointly or a qualifying widow or widower, or $200k as a head of household.
Having You Considered Rolling Your Income Over?
If you're thinking about staying with rental properties, then consider using a 1031 exchange to eliminate a large portion of the capital gains tax that you may be facing. This exchange allows you to trade one rental property for another as long as the value is equal to or more than the last property that you owned. You'll need to designate a new property within a certain time frame of your rental property's sale and close on the new property within 6 months, this is a good way to eliminate the worries of a capital gains tax.
It is also important to remember that certain fees which you have during the buying and selling process are deductible. Commissions, closing costs, legal fees, and other sales related fees are all removed from the income that is subject to the capital gains tax. You'll also be able to add in any costs that you've put into the home, like a new roof, so that you're comparing the sales amount to your total adjusted basis after all improvements and expenses.
Being able to limit the amount of tax responsibility you have on a rental property sale is important. For specific questions about your unique situation, be sure to consult with a tax advisor
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