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Capital gains taxes on rental property sale

Dear Tax Talk,
My husband and I recently sold a rental property that we had owned. We made a $20,000 profit from the sale of the property. We assume and understand this amount will be taxed (capital gain). We would like to be prepared and set aside the amount we are responsible for paying at the end of the year. What is the percentage? How can we figure this out? We have been unsuccessful in locating clear answers to our questions. Please help, or could you refer us to someone who can? Thank you. -- Britton

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Dear Britton,
To get the right answer, we have to understand if you're talking about profit or cash that you received at closing, which are two different things. Your tax profit is the difference between what you paid for the property and what you sold it for. The cash you get at closing is affected by the amount of your mortgage(s), which doesn't change your cost.

In addition, since this was rental property, you have to reduce your cost by the depreciation that was allowed or that should have been allowed. You don't mention anything about depreciation. Depreciation is an annual deduction intended to recover your cost in the property against the income that you receive. Residential rental property is depreciated over 27.5 years, commercial property over 39 years. If you've never claimed depreciation on the property, the Internal Revenue Service will still make you pay tax as if you had. You may want to consider amending your tax returns.

When you sell the property, the portion of the gain that is attributable to depreciation is taxed at a higher rate. If the property cost you $100,000, and the depreciation allowed or allowable was $10,000, then the cost for measuring gain is $90,000. If you sold the property for $120,000, then your total capital gain under that scenario would be $30,000. The first $10,000 in gain, representing depreciation recapture, is taxed at 25 percent. The $20,000 gain in excess of your original cost is taxed at the preferential rate of 15 percent. If your income for the year is lower, these rates can also be lower. So if your gain is really $20,000 and you don't have recapture to worry about, you should set aside $3,000 (15 percent of $20,000). If you didn't claim depreciation, you probably should see an accountant to help you straighten this out.

Bankrate.com's corrections policy
-- Posted: June 24, 2005
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