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How Are Rental Properties Taxed?

Estate Planning

Buying or selling income property has definite tax consequences. A taxpayer should clearly understand them, whether he or she intends to acquire a property or put one on the market.

A sale of income property incurs either a capital gain or loss. If you profit from the sale of income property, that profit is considered fully taxable by the Internal Revenue Service. Fortunately, if you have owned that property for at least a year, you will pay only capital gains tax on those profits rather than income tax.

Your capital gain is determined by subtracting the adjusted basis of the property (i.e., the price you paid for it, plus the total of any renovations, closing costs, and eligible legal fees) from the sale price. For most taxpayers, the capital gains rate is but 15%. If you sell an investment property for a capital gain of $30,000 and your capital gains rate is 15%, you will pay $4,500 of capital gains tax from the sale.

Depreciation can factor into this. If the market turns south and you can deduct $20,000 in depreciation within your ownership period, then your capital gain from the sale is $10,000 instead of $30,000.

Should you happen to sell one investment property at a gain and another at a loss in the same year, you can subtract your capital loss from your capital gain, resulting in a net capital gain or loss for that tax year.

Should you buy & hold, you could qualify for the homeowner exclusion. If you live in an investment property for two or more years during a five-year period, the I.R.S. will consider that investment property to be your primary residence, whether you do or not. You are, thereby, eligible for the federal homeowner exclusion when you sell such property, which enables you to shield up to $250,000 of capital gains from tax. Joint filers may exclude up to $500,000 of capital gains from tax through this break.

Income property investors may also qualify for some federal tax deductions. If you happen to utilize an investment property (or even a vacation home) for your personal use, you may be able to take advantage of property tax deductions, the mortgage interest deduction, even the home office deduction. The size of a deduction typically corresponds to how frequently you use the property. For example, you can deduct property management fees, insurance premiums, and certain other costs only when you use the property for longer than 14 days or 10% of the total days it is rented or leased.

This article is simply an overview of the tax rules on rental property. To fully explore the tax implications of a sale or purchase and the deductions and exclusions you may qualify to receive, speak to a qualified tax, real estate, or financial professional today.

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About the Independent Financial Advisor

Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.

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