Capital Gains Tax

If you sold an income producing property after May 5, 2003, your gain will be taxed at the following capital gains rate. For income property held more than one year, investors in a 25% or greater marginal tax bracket will be taxed at a 15% long term capital gains rate and a 25% recapture depreciation tax rate. Investors in a 15% or lower marginal tax bracket will be taxed at a 5% long term capital gains rate and a 15% recapture depreciation tax rate. In 2008, for investors in a 15% or lower tax bracket, the 5% capital gains rate is eliminated for one year and then reapplied in 2009.

Recapture depreciation taxes work like this. The total of all depreciation taken on the building during the period that you owned your income property plus all accumulated depreciation taken on any improvements to the buildings are subject to the recapture depreciation tax rates above.

Capital Gains Rate Example: You bought an income property for $500,000 and held the property for 5 plus years. During that period, you claimed $100,000 in depreciation deductions before selling the property for $750,000. Your adjusted basis for the property is $500,000 minus $100,000 or $400,000. Your profit from the sale is $750,000 minus $400.000 or $350,000. If you are in a 28% tax bracket when you sell the property, the $100,000 portion of your gain attributable to depreciation will be taxed at 25%. The remaining $250,000 of gain will be taxed at the capital gains rate of 5%. Your capital gains tax on the sale would be $100,000 times .25 or $25,000 plus $250,000 times .15 or 37,500. For this example, you will owe the IRS capital gains taxes of $62,500 from the sale of your property.

For the above example, if you were in a 10% marginal tax bracket when you sold the property, you would owe the IRS $100,000 times .15 or $15,000 for the $100,000 of depreciation taken and $250,000 times a capital gains rate of .05 or 12,500 for the remaining $250,000 of gain for a total of $27,500.

Note that if you paid a sales commission on the sale of your income property, your gain or profit from the sale would be reduced by the amount of the sales commission.

For income property held less than one year, you will be taxed at ordinary income tax rates.

What value should I use for my Federal Capital gains rate and Recapture Depreciation tax rate?

For those of you in a 25% tax bracket or higher, your long term capital gains rate is 15% for real estate investments held more than one year. A flat rate of 25% is applied to gains attributable to depreciation. For example, if you bought a 4 unit residential income property for $250,000 and over the years you claimed depreciation deductions of $100,000 and you now sell the property for $400,000, your adjusted basis becomes $150,000 ($250,000 – $100,000 of depreciation). You are left with a profit of $250,000 ($400,000 – $150,000). Under the new tax rules, $100,000 would be taxed at 25% and $150,000 would be taxed at 15%.

For those of you in a 15% federal tax bracket, your federal long term capital gains are taxed at 5% and the amount attributable to depreciation is taxed at 15%. In the above example, $100,000 would be taxed at 15% and $150,000 would be taxed at 5%.

Can I deduct rental losses?

If you are an active participant in an income property investment, the following rules apply. For Adjusted Gross Incomes (your income before subtracting itemized deductions, exemptions and rental losses) under $100,000, a maximum of $25,000 in losses can be deducted. If your AGI is between $100,000 and $150,000, the loss allowance is reduced by 50% of your AGI over $100,000. For example, if your AGI is $110,000, you can deduct $20,000 in losses ($150,000 – $110,000) / 2. If your AGI is $125,000, you can deduct $12,500 in losses ($150,000 – $125,000) / 2.

The “On Target” default is active participant. If you will be actively involved in the management of the property you are analyzing, set real estate professional to “N” and passive participant to “N” ( the default ).

The only time you need to be concerned about the “On Target” tax settings is when you have a loss or negative income on the Income statement. If you have a positive income, it doesn’t matter if you are a real estate professional, active participant or passive participant, you will be taxed the same.

What recovery period should I use to depreciate commercial and residential income property?

When analyzing property with the real estate investment model, use 27.5 years for residential properties and 39 years for commercial properties.

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