Sale of Residential Rental Property

You recently asked about the tax consequences should you decide to sell depreciable real estate at a gain. The following discussion of the tax consequences assumes that (1) your income, other than amounts treated as capital gain, is taxed at a marginal rate of at least 25%, and (2) the real estate sold is the only business asset sold by you in the tax year of the sale.

Generally, the gain from the sale by a noncorporate taxpayer of real estate that is a capital asset (or is used in a business) and is held more than 12 months isn't taxed at a rate higher than than 15% (20% for gain taxed at a 39.6%  rate had it been ordinary  income.).

But a more complex set of rules comes into play when the asset sold is depreciable real estate. This is so because, in that case , a maximum rate of 25% will apply to what's called unrecaptured section 1250 gain and a maximum rate of 15% (20% for gain taxed  at 39.6% had it been ordinary income) will apply to the balance of the gain. “Unrecaptured section 1250 gain”  refers to the portion of gain that is eligible for capital gain treatment even though it is attributable to previously allowable depreciation. A further complication is that the portion of the gain that is unrecaptured section 1250 gain depends, as shown below, on when the property was placed in service.

Thus, if you sell, at a gain of $200,000, a building on which $90,000 of depreciation deductions were allowable to you through the time of sale, $90,000 of the gain is unrecaptured section 1250 gain that will be taxed at a rate of 25%. The remaining $110,000 of the gain will be taxed at a rate of 15% (20% for gain taxed at 39.6% had it been ordinary income).

If you have further questions about the above rules or would like me to compute the potential tax that you face, please let us know.