The Tax Liability of Selling an Investment Property

by Ron White

Selling investment property requires some careful calculations. In addition to negotiating a sale price and finalizing the deal, you must factor in the tax impact of parting with your investment. When you sell investment property, you may need to pay tax on a portion of the sale price. By understanding the rules relating to investment property sales, you may determine your tax liability and use this knowledge to guide you through the sales process.

Capital Gains

When you sell investment property, you must pay tax on any financial gain you received. The profit on the sale of the property takes into account the cost basis, or the value of the property when you purchased it. You may adjust the cost basis if you paid for improvements to the property. The adjustment increases the cost basis of the property according to the actual cost of the improvements that you made. If you received the property as a gift or through inheritance, the cost basis represents the fair market value of the property at the time you took ownership. You may calculate your profit by subtracting the cost basis from the sale price. This profit is subject to a special tax dubbed the capital gains tax, the rate of which differs from that on regular income.

Capital Gains Rate

The tax rate that applies to capital gains depends on two primary factors. It varies based on whether you receive a short-term or long-term gain. A long-term gain exists when you sell the property 366 days or more after purchasing it. A short-term gain exists if you sold the property in 365 or fewer days after you purchasing it. Short-term capital gains rates are determined based on regular income tax bracket rates. Essentially, you pay tax on your gain as a part of your regular income. Long-term federal rates for 2011 maxed out at 15 percent. If your federal income for the tax year placed you in the 10 percent or 15 percent tax bracket, you pay no federal tax on a long-term capital gain. If your federal income tax bracket places you above the 15 percent federal bracket, you pay a 15 percent long-term capital gains tax on your profit from the sale of the investment property. State capital gains rates vary by state.

Lost Income Factor

While you must pay tax on any capital gains from selling your property, you could benefit, too. Since you no longer earn income from the investment property, your total taxable income will decrease. This is particularly important when you earn a significant amount of income from your investment property. This loss of income could push you into a lower tax bracket and could lessen the burden of having to pay a capital gains tax. To gain an idea of how it will affect your tax bill, you may adjust your income accordingly for the most recent tax year and determine whether that puts you in a lower tax bracket. Then apply the corresponding tax rate to what your taxable income would be without the investment income. By comparing the tax you actually paid for that tax year to an estimate of what you might have paid without the investment income, you may gain a better understanding of the impact.

Loss of Some Deductions

When you sell an investment property, you also lose some of the tax deductions you might have claimed had you still owned the home. You may claim deductions for mortgage loan interest, homeowner’s insurance and depreciation. These deductions lessen the tax on your investment income. If such deductions are greater than your investment income, the loss of these deductions has an even greater impact. It no longer counts against your other income, and your taxable income could be higher, which could place you in a higher tax bracket. Normally, the investment income is greater than the allowable deductions for the property, but this might not be the case if the property was vacant for a portion of the tax year.

About the Author

Based in Central Florida, Ron White has worked as professional journalist since 2001. He specializes in sports and business. White started his career as a sportswriter and later worked as associate editor for Maintenance Sales News and as the assistant editor for "The Observer," a daily newspaper based in New Smyrna Beach, Fla. White has written more than 2,000 news and sports stories for newspapers and websites. He holds a Bachelor of Arts degree in journalism from Eastern Illinois University.

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