How do you estimate the taxes that would be due on the sale of investment property?
Q: Is there an easy way to calculate the tax consequences on the sale of my investment property?
A: Yes. You get a quick estimation by subtracting your current basis from the sales price net of selling expenses (and not including mortgage payoff). Your current basis is calculated by taking what you originally paid for the property subtracting any depreciation you’ve taken and adding any capital improvements made to the property. (Note: These types of adjustments are typically only made to improved property- see Example #2 below.) Example #1: Jane bought unimproved land (raw land) for $200,000 and is now selling it for $420,000. She will be paying $20,000 in selling expenses, effectively lowering her net sales price to $400,000. When we subtract her basis of $200,000 from the net sales price of $400,000, Jane would have a $200,000 gain. Based on the current federal long-term capital gains rate of 15%, she would owe $30,000 in federal taxes. If the property is in a state that levies income taxes or if the state in which Jane files her tax return has a state income tax, then she would also be subject to a state tax on the gain.
Example #2: Alex owns an improved property that has been depreciated on his tax return, but which has luckily appreciated in value over time. Five years ago, he bought his rental house for $200,000. Alex is currently selling the property for $315,000 and paying $15,000 in selling expenses. There is no debt on the property. During his ownership, Alex has reported $50,000 worth of depreciation on his tax return.
His gain will be broken into two components - (1) long-term capital gain and (2) recapture of depreciation gain. The first step is calculating his adjusted basis in the property. From the original amount he paid of $200,000, Alex will need to subtract the $50,000 of depreciation expensed, lowering his adjusted basis to $150,000. Subtracting this adjusted basis of $150,000 from the $300,000 net sales price, leaves him with $150,000 worth of gain. This amount is taxed at two different rates based on how it is classified for tax purposes. $100,000 is considered a long-term capital gain and is taxed at 15% federal rate ($15,000), while $50,000 of the gain is considered a recapture of depreciation and taxed at a 25% recapture depreciation rate ($12,500). As in Example #1, Alex might also owe any associated taxes in the state in which he files his return or in the state in which the property is located.