Capital Gains Tax Rates on Real Estate Sales

Taxes on Property Appreciation and Deprecation

When you sell real estate you are taxed on both the appreciation and the depreciation. Each has its own tax rate. The capital gains tax rate (now 15%) is applied to the appreciation (or gain in market value). The second tax (25%) is on the deprecation taken by the taxpayer. The gain due to deprecation is usually higher than the gain due to appreciation, especially if the property was held for a long time.

How to Defer All Taxes

Some investors defer all capital gains taxes using a 1031 exchange. The principles are similar to the 401k and IRA programs used by stock market investors. In 1984 tax codes changed making 1031 exchanges more flexible and popular. Still, many property investors and real estate agents haven't heard about 1031 exchanges and end up pay taxes that could have been deferred.

Two Examples of How to Calculate Taxes on a Property Sale

Tom and Mary buy an apartment building in 1984 for $200,000. They set up the standard 80/20 depreciation allowance on a 30 year schedule taking $5,300 of depreciation each year.

20 years later, they sell the property for $600,000, their tax liability is $85,000.
$600,000 sale price
-100,000 adjusted basis
$500,000 gain

How to calculate the gain:
$100,000 depreciation recapture
$400,000 appreciation
$500,000 gain

The tax consequences:
$100,000 depreciation recapture X 25% tax rate = $25,000
$400,000 appreciation X 15% tax rate = $60,000
Total tax = $85,000

This is equal to a 17% blended rate ($85,000/500,000 = 17%)

If they sold after 7 years instead of 20 years, their tax would be $18,700:

$263,000 sale price
-163,000 adjusted basis
$100,000 gain

How to calculate the gain:
$ 37,000 depreciation recapture
$ 63,000 appreciation
$100,000 gain

The tax consequences:
$37,000 depreciation recapture X 25% tax rate = $9,250
$63,000 appreciation X 15% tax rate = $9,450
Total tax = $18,700

This is equal to a 18.7% blended rate ($18,700/$100,000 = 18.7%)

Using a 1031 exchange it's possible that all of the taxes in both examples could be deferred.

If you are considering selling property contact us today or ask an expert on-line to find out if you can defer the taxes.