Owning a rental house can be an effective way to earn extra income from monthly rental payments. However, if you no longer want the responsibilities of maintaining a rental property, or you simply need a lump sum of cash, you can opt to sell the property. In some cases, the capital gains you receive from the sale of a rental property may be subject to taxation.
Capital Gains Tax
When you sell a rental property that you have not lived in for the five-year period prior to the sale, you are responsible for paying capital gains tax on any profits you realize from the sale. The capital gain is the profit you make on selling the property. Capital gains are taxed at the standard tax rate for your income bracket; however, your capital gains, when added to your taxable wages, may put you in a higher tax bracket than if you had not sold the rental property. This may raise the percentage of income you pay on both wage income and capital gains.
Capital Gains Exemption
You may claim an tax exemption on capital gains realized from the sale of a rental property if you used the property as your principal residence for at least two of the five years before the sale. The two years do not have to be consecutive. For example, if you live in the property during the first and last year of the five-year period, and rent the property to tenants for the other three years, you can exempt capital gains from taxation.
Partial Capital Gains Exemption
If you used the rental property as your primary residence for less than two out of the five years before the sale, you may claim a partial exemption on capital gains tax. Divide the number of months that you lived in the rental property by 24, then multiply your capital gains tax by the result to determine the amount of capital gains that are exempt from taxation. For example, if you lived in the property for 12 months during the five years before the sale, you can claim a tax exemption on half of your capital gains from the sale of the rental property.
If you are single, you can exempt capital gains of up to $250,000 from the sale of a rental property if you lived in the home for at least two out of the last five years. If you are married, you can realize capital gains of up to $500,000 on a tax-free basis.
- BankRate.com; Capital Gains Home Sale Tax a Boon for Owners; Kay Bell; October 2004
- "Property and Taxation"; Jimmy D. Prince, FCPA; 2011