How to determine capital gains on sale of rental property?

Question

Hi all,

I see a few different calculators out there but each one gives different results. Perhaps someone help or point me in the correct direction. I'll be selling my only rental soon and wanted to determine the capital gains owed if I don't do a 1031 exchange. The stats are: house purchased almost 11 years ago (yes, top of market..) for 176,000 and we lived it the home for about 6 years and have rented it out for the past 4.8 years. Say I get 188,000 sales price today and I took depreciation of around 6400 for the past 4.8 years. No major improvements or additions except carpet, water heater, and a toilet. What might i possibly owe in taxes? Calculators are giving me different amounts.

Dave Toelkes · Answer

@Wayne Brooks,

When a primary residence is converted to a rental, its tax basis becomes the lower of the actual cost basis or the FMV at the time of conversion.  Once you reset the tax basis, then you subtract the land value to arrive at depreciation basis.

The reason for resetting the tax basis is simple.  The tax code does not let you recognize a loss of the sale of your primary residence, whereas, you are allowed to claim a capital loss on the sale of an investment property.  If your primary residence has declined in value at the time it is converted to a rental, the IRS requires you to reset the tax basis to prevent you from converting a non-deductible loss on your primary residence to a deductible loss on the sale of an investment property.  Any loss in vlaue after conversion becomes a deductible capital loss, and any gain on the sale from the new lower tax basis becomes a taxable capital gain.

Nicole Bernshaw · Answer

Wayne, I will refer you to a good article on the topic:

https://www.thetaxadviser.com/issues/2008/jul/conv...

https://www.thetaxadviser.com/issues/2008/jul/convertingaresidencetorentalproperty.html        Essentially, when a personal residence is converted to business use (or for use in the production of income), its starting point for basis for depreciation is the lower of (1) the adjusted basis on the date of conversion, or (2) the property’s fair market value (FMV) at the time of conversion (Regs. Sec. 1.168(i)-4(b)).

Basically your property had 2 bases: one when you purchased it (say $150K) and one when you converted it for business purposes, which is calculated according to (1) or (2) in the paragraph above.

Wayne Brooks · Answer

Looks like you already have your answers:

If your marginal tax rate this year is 15%, you pay 15% on your depreciation recapture.

If you're in a tax bracket where you pay 15% on your cap gains, then it's 15% on whatever your Net sales price is after closing costs, minus your $176k (which might be close to zero).  Note, this assumes no cap improvements as you stated, and don't forget to add any closing cost when you Bought, that you couldn't deduct then(settlement fees, title insurance, etc.) on top of your $176k to establish your purchase basis.

Not an accountant, just the view from 10,000'.

Steven Hamilton II · Answer

You need to know what your adjusted basis of the property is in order to do so. You will pay recapture up to 25% between your adjusted basis and your original basis. You will then pa capital gain on the amount above that.

We don't know what your capital gain rates are or your tax brackets. This is information I'd recommend contacting your accountant and running the numbers on. You need to initiate the 1031 exchange BEFORE you close on the sale.@Bill Exeter @Dave Foster

Wayne Brooks · Answer

@Nicole Bernshaw If I'm not mistaken, for cap gain purposes, your basis is your basis, period.  The FMV at the time of conversion to a rental property only factors in as far as your Depreciable basis is concerned.

Nicole Bernshaw · Answer

Your basis is the FMV of the P when it was converted from personal residence to rental. From that, subtract the depreciation and all the expenses you put into the P during the rental period. Subtract the result from your selling price and this will give you your profit.

In case you do not read all the posts, I have suggested the following earlier: you may want to contact Mark Kohler at KKOSlawyers.com. Mark is a real estate investor, attorney and CPA, and tax advisor. He even trains IRS people. He knows exactly what real estate investors need. You can also google his name.

Dave Foster · Answer

the biggest impact is going to be the net sales price and not the 188K contract price.  @Wayne Brooks is right on.  You may not see much gain at all other than depreciation recapture once your selling expenses are netted out including the exchange fee of around $750.

Ivan M. · Answer

Thank you both for responding. Unfortunately, I do not have an accountant as I have self prepared  most of my returns in the past. Something tells me though...this year I will find an accountant. However, back to the question. As I was traveling when i wrote the question....the depreciation taken each year was only 4582 for say 4.8 years and not 6400. An actual accountant did help me come up with the 4582 figure when I first put the home out to rent looking back at the paperwork now. I'm in South Carolina and I'm fairly certain my capital gains take rate would be 15% federal (not sure if I should factor in state capital gains in this scenario?) and I also believe my tax bracket should be in the 15% range too. Does this information help anybody get me a little closer to an answer to my question?  Again, the reason I'm asking is that calculators were coming up with 4k to 12k...so I'm a little confused. Carl, I'd love to only be 1800 if possible.

Carl Fischer · Answer

This is a simple question for your accountant if he has been doing your taxes for the last 5 years. He will have your depreciation, capital expenditures, cost basis, tax rate, tax bracket.

My guess would be no more than 15% of $12k or $1800  especially when selling costs get factored in.

How to determine capital gains on sale of rental property?

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