How to Calculate Capital Gain on Rental Property Sale

Knowing how to calculate capital gain on the sale of rental property is crucial for gauging your overall profit and potential liabilities. Yet, for many, navigating this process can feel overwhelming.

Factors such as purchase prices and property improvements frequently result in mistakes, creating uncertainty around tax obligations and impeding confident real estate decisions. The fear of inaccuracies can stifle financial progress and portfolio expansion.

Fortunately, there’s a solution. By following the guidance provided in our comprehensive guide below, you can ease the complexities associated with these calculations and streamline your path to success.

How to Calculate Capital Gain on a Rental Property

When determining the capital gain on a rental property, it’s essential to follow a systematic approach. Start with the original purchase price, incorporate any additional expenses like renovations or improvements, and then subtract these from the selling price along with the costs associated with the sale, such as commissions and fees. Here’s a straightforward formula:

Capital gain = (Purchase price + Improvements) – Selling price – Cost of Sale

Identify the Original Purchase Price

Begin by noting the original purchase price paid for the property. For instance, if the property was acquired for $300,000, this figure serves as the baseline for your capital gains tax calculation.

Include Additional Expenses

Factor in any supplementary costs accrued during your ownership, such as renovation expenses, repairs, and improvements. These outlays contribute to the property’s adjusted basis.

Account for Depreciation

Account for the depreciation of the property over the duration of ownership. This depreciation reduces the adjusted cost basis subject to capital gains tax.

Calculate the Adjusted Basis

Determine the adjusted basis by summing up the original purchase price, additional expenses, and depreciation. This adjusted basis reflects the total investment in the property, accounting for fair depreciation over time:

Adjusted cost basis = original purchase price + expenses – depreciation

Determine the Selling Price

Consider deducting certain fees from the selling price to lower your capital gains tax liability. These may include legal and professional fees, property taxes related to the sale, and marketing expenses.

For example, if the listed selling price is $300,000, but associated selling costs amount to $5,000, the net selling price for tax calculation would be $295,000 ($300,000 – $5,000).

Calculate Capital Gain

Subtract the adjusted basis (Step 4) from the selling price (Step 5) to obtain the capital gain from the rental property. The formula is:

Capital gain = Listed selling price – related selling costs – original purchase price + additional expenses – depreciation

Report the Sale

Ensure compliance with California state tax regulations by accurately reporting the sale of the rental property. Complete Schedule D of Form 1040 and file Form 4797 if depreciation has been claimed previously. Adhering to these reporting requirements facilitates a smooth and legally compliant property sale process.

how to Calculate Capital Gain on Rental Property Sale

Example of How to Calculate Capital Gains on Rental Property

Let’s consider a scenario where an investor, operating under the banner of Sell Quick California, acquired a commercial office building in downtown Los Angeles five years ago for $3.5 million and further invested $200,000 in renovations and enhancements.

To compute the capital gains tax on this investment property, which was sold for $5 million (post-selling fees) in 2024, the investor would proceed as follows:

Establish the Basis:

Original Purchase Price: $3.5 million Capital Improvements: $200,000 Total Basis: $3.7 million

Account for Depreciation

Commercial real estate typically undergoes straight-line depreciation over 39 years. Assuming the building’s original cost (excluding land) was $3 million (including capital improvements), the accumulated depreciation over five years would be approximately $384,615 ($3,000,000 / 39 years = $76,923 x 5 years).

Determine Adjusted Basis

Adjust the basis by subtracting the depreciation from the total cost basis: $3,700,000 – $384,615 = $3,315,385 adjusted basis.

Calculate Capital Gain

Capital Gain = Selling Price – Adjusted Basis

= $5,000,000 – $3,315,385

= $1,684,615 capital gain.

Assess Depreciation Recapture Tax

Depreciation recapture is subject to a flat rate of 25%. For the accumulated depreciation ($384,615), the tax liability for depreciation recapture would amount to $96,153.75.

Calculating Capital Gains Tax

Let’s delve into the intricacies of calculating capital gains tax (CGT) for a property sold under the auspices of Sell Quick California. In our scenario, an investor disposes of a commercial office building in downtown Los Angeles, originally purchased for $3.5 million, with $200,000 invested in renovations. The property is sold for $5 million (after selling fees) in 2024.

Compute Federal CGT:

The remaining capital gain after accounting for depreciation ($1,684,615 – $384,615 = $1,300,000) is subject to federal CGT.

Federal CGT applies at varying rates for short-term (less than 1 year) and long-term (greater than 1 year) holds.

Considering the property was held for over 1 year, long-term rates are applicable. Based on filing status, the rate is determined:

For our example, with a gain of $1,300,000, the long-term rate of 20% applies, resulting in a federal CGT of $260,000.

Assess California State CGT:

California’s CGT rates align with personal income tax brackets, contingent upon filing status.

In our case, with a gain of $1,300,000, the state CGT rate of 12.3% applies. Thus, the state CGT amounts to $159,900.

Determine Combined Federal and State CGT:

The total CGT for 2024 is the sum of federal and state CGT:

Combined federal and state CGT = Federal CGT + State CGT = $260,000 + $159,900 = $419,900.

By meticulously navigating federal and state CGT structures, Sell Quick California ensures transparent and comprehensive tax planning for property transactions, empowering investors to make informed financial decisions.

Additional Taxes:

In addition to federal and state capital gains taxes, investors with income surpassing Affordable Care Act (ACA) surtax thresholds may incur an extra 3.8% on the total capital gain.

For our example, the investor’s total capital gains tax liability includes:

Depreciation recapture tax: $96,153.75 Federal long-term capital gains tax: $260,000 California state capital gains tax: $159,900 TOTAL = $513,053.75

It’s crucial to note that tax regulations, particularly concerning capital gains tax on investment properties, are subject to change, and individual circumstances vary. Seeking guidance from a tax professional is indispensable for precise calculations and tailored advice aligning with your specific situation.

Key Takeaways on Calculating Capital Gains on Rental Property

Mastering the art of calculating capital gains on the sale of rental properties is paramount for investors.

Here are the crucial insights to remember:

  1. Basis Calculation: Initiate your calculation journey by establishing the original purchase price and incorporating any additional expenses like improvements. This forms the bedrock for computing capital gains.
  2. Depreciation Adjustment: If you’ve availed depreciation on the property, deduct it from the adjusted basis. Depreciation significantly impacts your capital gains tax liability when selling your investment property.
  3. Capital Gain Calculation: Deduct the adjusted basis from the selling price to ascertain the capital gain. This value mirrors the profit accrued from the property’s sale.
  4. Tax Implications: Grasp the tax ramifications of capital gains. Depreciation recapture adheres to a distinct rate compared to the remaining capital gain, which is subject to long-term capital gains tax rates. Both federal and state taxes come into play.
  5. Consultation is Crucial: Given the intricate nature of tax laws and the individual nuances of investment scenarios, seeking guidance from a tax professional is imperative. They furnish precise calculations and offer tailored advice tailored to your unique circumstances.

By internalizing these key concepts, investors can maneuver through the labyrinth of calculating capital gains on rental properties with finesse, empowering them to make astute financial decisions in the dynamic real estate arena.

Home Owner Resources

Stop Foreclosure In CaliforniaProbate Sale In California
Can You Sell A House That Is In Pre Foreclosure In CaliforniaSelling Inherited Property In California
Can You Sell A Condemned House In CaliforniaHow to Sell a House by Owner In California
How to Sell a Hoarder House In CaliforniaHow to Sell Rental Property with Tenants in California
Selling a Fire Damaged House In CaliforniaHow to Sell Rental Property In California
Selling A House During Divorce In CaliforniaCapital Gains Tax On Selling A House In California
Marc Afzal- Real Estate Investor

Marc Afzal is a full time Real Estate Investor and has well over 21+ years in the Real Estate Industry. Marc is a Licensed Broker, NMLS licensed Loan Officer. Marc is currently married to his wife Sheila and they live in Napa California. Marc is enthusiastic about Sports, Golf, Real Estate Investing, Family and Travel.

About Marc Afzal

Marc Afzal is a full time Real Estate Investor and has well over 21+ years in the Real Estate Industry. Marc is a Licensed Broker, NMLS licensed Loan Officer. Marc is currently married to his wife Sheila and they live in Napa California. Marc is enthusiastic about Sports, Golf, Real Estate Investing, Family and Travel.

Leave a Reply

Your email address will not be published. Required fields are marked *

Call Us!