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  • Writer's pictureKyle Flischel, CPA

Tax Considerations When Selling a Rental Home



Selling a rental home involves different tax rules from selling a primary residence and can have substantial tax implications. Here’s a comprehensive guide to help you understand the tax aspects of selling your rental property.


Capital Gains Tax


When you sell a rental home, any gain from the sale is generally subject to capital gains tax. The gain is the difference between the selling price and your adjusted basis on the property. The adjusted basis is the original purchase price, plus improvements, minus any depreciation claimed. You will need to report the sale of your rental home on your federal tax return. In addition to federal taxes, state taxes may also apply. 


The capital gains tax rate depends on your taxable income and how long you have owned the property. Properties owned for more than one year are considered long-term capital gain and are typically taxed at lower rates than short-term gains. Short-Term Capital Gains Rates are taxed at your ordinary income tax rate, but Long-Term Capital Gains are taxed at either 0%, 15%, or 20%, depending on your income.


You'll need to account for depreciation recapture upon sale. Depreciation recapture, taxed at a maximum rate of 25%, is the gain realized by the sale of depreciable capital property that must be reported as ordinary income. 


Strategies to Minimize Capital Gains Taxes


A 1031 exchange allows you to defer paying capital gains tax if you reinvest the proceeds from the sale of your rental home into a similar type of property. This can be a beneficial strategy if you plan to invest in another rental property. The conditions for 1031 Exchange include:

  • The new property must be similar in nature and function.

  • You must identify the replacement property within 45 days of selling your rental home and complete the purchase within 180 days of selling the prior home.

  • Both properties must be held for investment or productive use in a trade or business.


Converting your rental home into a primary residence before selling is one strategy to minimize taxes. If you live in the property for at least two of the five years before the sale, you may qualify for the primary residence capital gains exclusion. If you do not meet the full two-year residency requirement but have a valid reason (such as job relocation or health issues), you may still qualify for a partial exclusion, although deprecation recapture is not eligible for the gain exclusion.


Tips for Minimizing Taxes


  1. Keep records of your purchase price, improvements, rental income, and any depreciation claimed.

  2. Plan the sale of your rental home to maximize long-term capital gains treatment.

  3. Tax rules for rental homes can be complex. A tax professional can help you navigate these rules and minimize your tax liability.


Conclusion


Selling a rental home involves several tax considerations, including capital gains tax, depreciation recapture, and the potential for a 1031 exchange. Understanding these factors and planning accordingly can help you manage your tax liability and make the most of your investment. Always consult with a tax professional to ensure compliance with tax laws and to explore strategies for minimizing taxes on your rental home sale.

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