Investing in real estate can be quite lucrative, and with plenty of room for profit, it’s easy to see why property ownership remains a popular investment. When it comes time to realize some of this profit, you can be certain that the IRS will expect its cut, and how long you hold onto the property determines how you’ll be taxed on your investment. However, simply owning investment property has tax implications, even if you are planning to hold onto it.
Real estate investors also claim losses on the property to help offset their gains. Familiarizing yourself with how your capital gains are taxed goes a long way towards getting the most out of your investment, and reducing your obligation to the IRS at tax time.
The length of time you have held an investment property will directly influence how much tax you pay during the sale. Assets held for more than a year are taxed at a considerably lower rate than assets held only for months.
Investment Property Tax Ramifications
A capital gain is any profit received from the sale of a capital asset. Capital assets are things such as stocks, real estate, bonds, collectibles or dividends. For tax purposes, profit from the sale of an investment property will be considered either a short-term or long-term capital gain. The fundamental difference between these two forms of gain is the length of time you held the asset.
If you hold onto an investment property for less than a year and sell it, then the proceeds from the sale of the property are taxed as income for the year, and are considered short-term capital gains. For short-term capital gains, whatever tax bracket you’re in is the rate at which you’ll be taxed up to the 2020 maximum of 37 percent. Also, depending upon your income level, you could be hit with a 3.8 percent Medicare surtax, part of the Affordable Care Act, as well. You report these short-term capital gains on your IRS Form 1040 using Schedule E, "Supplemental Income and Loss."
Long-term capital gains, on the other hand, are the proceeds from the sale of an asset you held for longer than one year, and fare much better as far as taxes are concerned. These gains are generally taxed at 0, 15, or 20 percent for the 2020 tax year. However, If you’re in one of the lower tax brackets, you may find yourself taxed at 0 percent on your long-term gains.
Understanding Tax Regulations
But, in true IRS fashion, there are different tax rules that apply to long-term capital gains from real estate. Investment property capital gains are taxed at 25 percent if you deduct depreciation on your tax return. This is a way for the IRS to recuperate some of the tax breaks and deductions you claim when you depreciate your property.
To determine your gains – and subsequently your tax rate – on investment properties, complete Schedule D, "Capital Gains and Losses" along with your Form 1040. The IRS’ website has more information and worksheets to assist, and Publication 544 thoroughly covers how to go about figuring the taxes on your investment property.
Deducting Capital Losses
You can deduct capital losses on your investment properties. These deductions apply to help you offset some of the capital gains you realized, both short and long-term. However, you can only deduct short-term capital gains with short-term capital losses, and the same applies to long-term gains and losses.
You can deduct up to $3,000 in any net capital losses against other types of income per year. If you find your capital losses exceeding this $3,000 limit, you may carry over your net losses to the following years, up to this limit. If you’re married and filing separately, then the limit you're able to deduct in capital losses is $1,500 per year.
Handling Rental Property Tax
If you are renting out your investment property, this has its own tax ramifications. You'll have to pay tax on the rental income, though you can often deduct expenses for maintenance, advertising, utilities and other costs related to the rental property. Keep records of the rent you receive, leases you sign and expenses you pay and document them on Schedule E of your Form 1040.
- IRS: Publication 544, Sales and Other Dispositions of Assets
- IRS: Instructions for Schedule E (Form 1040)
- IRS: About Schedule D
- SSA CPA: How the New Tax Law Affects Rental Real Estate Owners
- IRS: Topic Number 409 - Capital Gains and Losses
- Internal Revenue Service. "Tax Topic No. 409: Capital Gains and Losses." Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 19. Accessed Jan. 2, 2020.
- Tax Foundation. "An Overview of Capital Gains Taxes." Accessed Jan. 13, 2020.
- Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2019." Accessed Jan. 2, 2019.
- Internal Revenue Service. "Publication 523: Selling Your Home," Pages 2–7. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 49. Accessed Jan 2. 2020.
- Internal Revenue Service. "Publication 946: How to Depreciate Property," Pages 3–4. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 67. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Find Out if the Net Investment Tax Applies to You." Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 544: Sales and Other Disposition of Assets," Pages 34–36. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 544: Sales and Other Disposition of Assets," Pages 35–36. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Publication 550: Investment Income and Expenses," Pages 56–57. Accessed Jan. 2, 2020.
- Internal Revenue Service. "About Schedule D (Form 1040)." Accessed Jan. 2, 2020.
- Internal Revenue Service. "Topic No. 412: Lump-Sum Distributions." Accessed Jan. 2, 2020.
- Internal Revenue Service. "Sales and Other Dispositions of Assets," Page 35. Accessed Jan. 2, 2020.
- Internal Revenue Service. "Mutual Funds (Costs, Distributions, etc.) 1." Accessed Jan. 13, 2020.
- Internal Revenue Service. "Publication 538: Accounting Periods and Methods," Pages 14–18. Accessed Jan. 2, 2020.
Tara Thomas is a Los Angeles-based writer and avid world traveler. Her articles appear in various online publications, including Sapling, PocketSense, Zacks, Livestrong, Modern Mom and SF Gate. Thomas has a Bachelor of Science in marine biology from California State University, Long Beach and spent 10 years as a mortgage consultant.