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6 Things to know before the sale of rental property

A rental property provides you with substantial income from cash flow in the form of rents. However, you may opt for the sale of a rental property if you want to capture the appreciation and hike in property prices. But, the profits you make by the sale of rental property can get seriously lowered by the cut in form of capital gains taxes. Here are some things you should know before the sale of rental property.

1. Capital Gains tax on the sale of rental property

  • Short-term capital gains tax – apply if you held the rental property for less than a year.
  • Long-term capital gains tax – apply when you hold the rental property for more than a year.

2. The rate of Capital Gains tax and additional taxes.

Short-term capital gains are taxed like the ordinary income, such as that of your wages. They may vary from 10% to 37% depending on the income tax brackets.
The rate of long-term capital gains tax varies from 0% to 20% on the profit. It depends on your income, marital status and the mode of filing the taxes. It has 3 slabs of 0%, 15%, and 20%. The lowest 2 tax brackets have a 0% rate. People from the third bracket onwards pay 15% tax. You would pay 20% tax if your income falls in the top tax brackets.
Also, an additional 3.8% tax is levied on those who earn above certain thresholds. Currently, this threshold is $200,000 for single or head of household, $250,000 for those who are married and are filing jointly, $125,000 for those who are married but filing separately. Moreover, some state and local taxes too get applied while making the sale of rental property.

3. Wait before you sell

It is better to wait for a year after the purchase for the sale of rental property. This is because the Long-term capital gains tax rates are comparatively lower as compared to Short-term capital gains tax for similar income.

4. Make it your residence

Do you know you can exclude up to $250,000 in gains from being taxed by turning your rental property into your main residence? This gets increased to $500,000 in the case of married couples. To make it count, you must have owned the property for at least 5 years. Also, you must use it as your primary residence for the last 2 years before the sale.

5. 1031 Exchange

This technique can be employed to defer the payment of capital gains taxes on the sale of rental property. You can use this tool if you are willing to reinvest the proceeds of the sale in acquiring a new property. Some conditions to be met out include:

  • The new property must be of “like kind” as that you are selling.
  • The property may be of greater or lesser value.
  • The exchanged property is to be used for business or investment related purposes.
  • The potential replacement properties must be identified within 45 days of the sale of rental property.
  • The exchanged property must be received within 180 days or your tax return due date, whichever falls earlier.

6. Pair the gains with losses

Reduce the tax liabilities by pairing your gains with the losses when you make the sale of rental property. You can offset the gains you made via the sales by pairing it with the losses you incurred during the year, say in the stock market. This method is also called as ‘tax loss harvesting’.
I hope the above article helps you to know some basic concepts which you may come across while you opt for the sale of rental property. Keep reading further for other relevant articles.

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