Q: I have a rental condo that I plan to sell by the end of the year. I am not planning to use the profit to purchase another property. Will I be liable for capital gains tax?
A: The short answer is “probably.” The real question is how much tax will you owe?
Let’s start at the top. How long have you owned your rental property? If you’ve owned it for less than a year, the investment is considered to be “short term”and you will pay tax as if your property is ordinary income. That tax will be at your current marginal tax rate, which could be a lot higher than capital gains tax.
If you’ve owned the rental property for at least a year, it’s considered to be a “long-term” investment and any profit you realize will likely be subject to the capital gains tax of either 5 or 15 percent, depending on your marginal tax bracket.
The only way I know of to defer capital gains tax owed is to swap the property for another investment property that costs the same or more. The swap is handled through a transaction known as a 1031 Tax Free Exchange, also known as a Starker Trust. It’s a bit complicated, and you have to purchase the new property within 180 days of selling the current investment property, but you then get to avoid paying taxes until the next property is sold.
For more information on 1031 tax free exchanges, talk to a real estate attorney who has plenty of experience with these types of transactions.
To read more about what tax is owed when you sell investment property, go to the IRS’s website (irs.gov) and download Publication 550 “Investment Income and Expenses” and Publication 527 “Residential Rental Property.”
If you expect to see a profit from the sale of your rental property, you may have to pay estimated taxes on that profit. Check out IRS Publication 550 “Tax Withholding and Estimated” for more information.
If you don’t have access to the Internet, you can call the IRS toll-free at 800-TAX-FORM and ask them to mail the forms to you.
Published: Oct 29, 2004
I’m planning on selling 2 rentals and use the profit to purchase another rental property in a different location. Will I still be liable for capital gains tax since the purchase price of the new rental would be more that the combine purchase price of the current rentals?