Investor Real Estate Accounts

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Capital Gains Tax on the Disposition of Residential Rentals

first posted: 2020-08-08 08:33:41.766457

Highlights

If a property is held for less than a year, the capital gains are taxed as ordinary income. This can easily make you move to higher tax brackets as capital gains can be large.

If a property is held for more than a year, the tax rate is lowered, this is consistent with the government's view that long term investment is a good thing to be encouraged, whereas short term speculation is taxed more.

Tax brackets for single taxpayer are:

  • 0% below $39,375 income
  • 15% below $434,550 income
  • 20% over that

The information required are - purchase price plus aquisition costs - amortisation expensed from purchase to sale of the asset - sale price minus sales costs

The capital gains declaration is done in form 4797 and 1040 Schedule D for residential rentals.

Depreciation

This is my understanding but I am not a CPA, so you might want to check the following.

According to this CGT article, the difference between sale and purchase is subject to capital gains tax whereas the amortization is called "unrecaptured section 1250 amortization gains" and is subject to up to 25% tax. However, once you do your taxes or you check the filings of professional preparer, you don't see this 25% tax. This more specific article on section 1250 and other resources on the web explain that since 1986 tax reform only the excess amortization over the straight line amortization would cause section 1250 recapture.

In short, the 1/27.5 of the cost basis that can be deducted linearly every year is not taxed when selling. Any accelerated depreciation beyond that such as that caused by seggregated depreciation of the various building components would cause unrecaptured gains subject to 25% tax when realising the capital gains.

Despite the 1986 simplification, the computation worksheet is complicated to ensure that someone in the lowes tax brackets would not be overcharged.

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