Tax Consequences of Selling Rental Property

Whenever you realize a profit from a rental property, then you will need to pay taxes on any gains that have occurred. Sometimes you can deduct losses that you take from the sale, but a lot of this depends on your specific circumstances. It all depends on what your tax basis happens to be at the time of the sale. The most important thing to remember when selling a rental property is that you're essentially giving back all of the depreciation deductions that you took out on it. This means your taxable gain will be increased by that amount. If you owned a property for 10 years and had $72,000 in depreciation, then you would have to pay a 25% tax on that amount after a sale. Everything else would be taxed at the current capital gains rate.

Why Take Depreciation If You Have To Give It Back?

Under current tax law, depreciation happens whether you claim it or not on your return. If you don't claim it, you'll still have this tax liability when you make a sale on the deductions that should have been taken. In this example, the seller would pay a 25% tax on the $72,000. The only things that can limit this amount are any investments that you have made into the rental property after owning it for at least 1 year. Let's say that you needed to put a new roof on that rental property and this cost you $25,000. The roof will increase the property's tax basis. You would remove the $25,000 from the $72,000, and then subtract this figure from the overall purchase price. That's the amount of taxable gain that you're looking at when you make a sale. Using these examples, let's say that you are selling this property for $700,000 today. You paid $500,000 for the property. You'd have an initial capital gain of $175,000 because of the $25,000 roof cost [assuming there was no depreciation on the roof because it happened in the last year]. Because you claimed depreciation, there would also be $72,000 that was subject to depreciation recapturing at the 25% rate.

Are You Going To Exchange Your Property?

There's a tax law that allows you to exchange your property for another property of equal or greater value without as many tax consequences. This 1031 exchange lets you trade several properties for other properties as well, so you could trade up several single family homes for a large apartment building. As long as there isn't an overall financial gain because the new property is worth less than the older property, then everything just rolls over. If not, then you'll pay the recapture and capital gains taxes on the sale. There may also be other taxes involved. In New York City, for example, you'd also owe state income taxes on any real estate gains and there would be a city tax on those gains as well. Look at your local laws, see what tax responsibilities may apply, and then make the right selling decision on your rental property.

Posted on Dec 06, 2014


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