If you sell real estate you've owned for a while at a profit, you could have a taxable capital gain. However, the tax rates that apply to long-term capital gains are different than those that apply to ordinary income, and there are some considerations specific to real estate you should be aware of.
With that in mind, here's a quick guide to long-term capital gains for real estate owners.
What is long-term capital gains tax?
When you sell an asset for more than what you paid for it, you have a capital gain. If you invested $1,000 in a stock and later sell it for $1,500, you have a $500 capital gain. And like most other types of income, capital gains are taxable.
In the eyes of the IRS, there are two types of capital gains: long term and short term. A long-term capital gain is a profit on the sale of an asset you've owned for more than a year, while a short-term capital gain is a profit on the sale of an asset you owned for a year or less.
Both types are taxable, but long-term capital gains are treated more favorably. Short-term gains are taxed as ordinary income, just as if you received it from a job, at whatever your ordinary income tax rate is. On the other hand, long-term gains have their own tax brackets, which we'll discuss in the next section.
Also, only your net capital gain, defined as the difference between your net selling price and your cost basis (specifically, your adjusted basis) is subject to tax. As a simplified example, consider this situation:
- You bought a rental property for $100,000 in 2010. You paid $2,000 in acquisition costs (like legal fees) when purchasing and also spent $18,000 on a new roof and renovating a bathroom. This makes your cost basis $120,000.
- You sell the rental property for $200,000 in 2020. You pay $12,000 in real estate commissions and $3,000 in other selling expenses, for a net sale price of $185,000.
The difference between your selling price and the purchase price was $100,000. However, the difference between your net sale price and cost basis was $65,000, the taxable capital gain. Investors also have to subtract any depreciation deductions they've taken from their cost basis for the purposes of this calculation -- a concept known as depreciation recapture.
2020 long-term capital gains tax rates
Long-term capital gains are taxed at a rate of 0%, 15%, or 20%, depending on the taxpayer's income.
To be clear, the long-term capital gains tax brackets will change from year to year, and the rates themselves could change at some point. But for the 2020 tax year, here are the three capital gains tax income tax brackets for the various tax filing statuses.