There are a variety of reasons why a property owner might consider selling a rental property – the property may no longer be profitable, you live too far away from your property, or the demands of being a landlord are greater than the profits being made from the rental income. Whatever the reason, selling a property has significant tax consequences that should be factored into any decision to sell.
Capital Gains Tax Rates
If you sell your rental property within one year of purchasing, you will owe short-term capital gains taxes. These are taxed as ordinary income.
For investment rental property owned longer than one year, your long-term capital gains tax rate will be 0%, 15%, or 20%. The percentage depends on your taxable income and filing status.
As an example, for 2021 taxes, a 15% capital gains tax would be owed by:
Anyone filing single with an income of $40,401 to $445,850
Or by a married couple filing jointly with an income of $80,801 to $501,600
Adjust the Basis of Your Rental Property
The original basis is what you paid to purchase the property. The original basis can be adjusted depending on specific expenses or gains from the property. The adjusted basis is then used to determine the capital gains taxes when you sell.
Increasing the basis could reduce the capital gains taxes you would owe.
This can occur when you invest in property with a new room or a new roof, restore property after a natural disaster, and with closing costs and related escrow fees, etc.
Decreasing the basis could increase your capital gains liability.
Deductions of Cost of Sale
When you sell an investment property, deductions of the costs of the sale can be claimed. These are costs such as:
Realtor commissions
Title fees
Closing fees
Attorney fees
Escrow fees
Notary fees
And more
Offset Gains with Losses
To reduce capital gains tax liability when selling a rental property, a common strategy is to include an investment loss in the same tax year as the gain on the rental property. If the owner has an investment that has lost value, selling that asset (usually stocks) at a loss can offset some of the gains from real estate sales.
Also, if your property has lost value since you originally purchased the real estate, the decrease in value can offset any gains, depending on the valuation. The losses associated with investment property are deductible.
Defer Gains with a Reinvestment
Another common strategy defers capital gains taxes owed. This is a 1031 tax-deferred like-kind exchange, which allows property owners to sell a property and immediately reinvest all the sales proceeds into another income-generating property. This defers payment of capital gains taxes, but you must reinvest with the time constraints to be eligible for the 1031 tax deferment. If you miss the deadlines, you must pay the capital gains tax liability in full on the sale of the original property.
The replacement property must be used as an investment, but it can be a different asset class, as long as both are income-generating rental properties.
The new property purchase price must be equal to or greater than the value of the sold property.
The name on the title of both the sold and the new properties must be the same.
The reinvestment property must be identified within 45 days of the sale of the first income property.
The reinvestment property must be purchased within 180 days of the sale of the first property. If the investor has a tax return due before those 180 days, they must close on the replacement property even sooner.
Let's Get Started
If you are considering selling an investment property, we can help you to determine your tax liability and to consider strategies to reduce your capital gain taxes owed. Call 985-727-9924 to speak with our expert team of Certified Public Accountants today.