Capital gains from selling an investment property. | VK Consulting LLC
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While working on real estate investment properties deals, I get a lot questions like “what is my taxes will be when I sell my investment property, is it true tax is 39%?”

Short answer is “NO”, longer answer is “anywhere between 0% and 25%.”

Every asset (example an investment property) has a basis. Basis is the amount taxpayer has invested into an asset. Cost basic is the purchase price plus commissions plus costs incurred to make the purchase. Adjusted basic is cost basic plus or minus adjustments. Fox example amount spent on a new roof will be added to cost basic, but depreciation claimed in the previous years will be subtracted from the cost basis.

Depending on the nature of the assets, gains can be taxed at the different rates. Most properties that taxpayer uses for personal or investment (primary residence, household furnishings, stocks or bonds, personal auto, jewelry, coins and stamp collections) use are capital assets.  However, anything that used in a business -land, buildings, equipment and inventory often referred as “capital assets” by public, are noncapital assets. Real property and depreciable property used in a trade or business are not capital assets. So “Investment property” which is used to produce rental income is not considered a capital asset.

Holding period: Short term-less than a year. Long term-more than 1 one year.

Sales price-adjusted basis= gain or loss

Sales price= amount realized from sale-any direct selling expenses such a commissions or brokerage fees.

To encourage and reward long-term capital investment, the federal government taxes capital gains at a lower rate than ordinary income.

Short term (less than a year) capital gains are taxes at the same rate as ordinary income. Assets that are held more than 365 days (long term) are taxed at 0%, 15% and 20%

Knowing all these information, let’s go back to original scenario, of selling a rental property.

Per IRS, Rental property is not a capital asset, it’s a noncapital asset, and would result in ordinary income tax rates; however, IRS section 1231 allows certain business assets to be treated as if they were capital assets. There are some steps involved in qualification of the business assets into IRS sections 1231, and then into 1245 and 1250, (which will not be discussed here) but in short taxpayer is required to calculate the “unrecaptured Section 1250 gain”- which is amount of the depreciation taken on the property that is not recaptured as ordinary income under Section 1250 and taxed at 25% and the remaining capital gain will be taxed at appropriate regular capital gains rate of 0, 15 or 20%.

As an example: Mr. Smith bought investment property 5 years ago for $478,000. Depreciation taken on this property over the years was $168,000. He sales his property for $756,000. Gain of the sale is $446,000.  $168,000 (depreciation) will be taxed at 25%, and remaining $446,000-$168,000=$278,000 is taxed at 20%.

Hope you enjoyed reading this and call us if you have any tax or real estate needs or questions.