Since 1922, tax law and tax rates have treated the profit associated with the sale of a business asset, including rental property, more favorably than ordinary income. Rules in effect since 2008 result in the taxation of rental property profits at no more than 15 percent if the property has been owned for at least a year. The same profits are taxed at ordinary tax rates, up to 35 percent, if the property has been owned for less than a year. If you sell rental property at a loss, it is referred to as a capital loss and is also classified as short-term or long-term.
Long-Term Capital Gain
Taxpayers earning more than $200,000 account for the lions' share of capital gains, according to a study by the nonpartisan Urban Institute. With an income in this range, and assuming no or limited deductions, these taxpayers are subject to ordinary income tax rates of up to 33 percent. Because the top rate on long-term capital gains is only 15 percent and the top rate on ordinary income is 35 percent, many taxpayers claiming capital gains benefit substantially from the relatively low capital gains tax. Even a moderate-income taxpayer, with a tax rate of 25 percent, benefits soundly from the capital gains rate.
Short-Term Capital Gain
If you have held a property less than one year, your capital gain is classified as short-term. Short-term capital gains are subject to taxation at the same rate as ordinary income. Because, as shown in the Urban Institute study, relatively wealthy taxpayers make use of most capital gains reported, tax law promotes holding rental property and other business assets at least one year.
Long-Term Capital Loss
Not every rental property sale results in a gain. If you held the asset more than a year but sold it at a loss, this is referred to as a capital loss. Capital losses may be used to offset capital gains. For example, if you sold one property for a $100,000 profit and sold another for a $60,000 capital loss, you would result with a net $40,000 capital gain. If your capital losses offset your capital gains, you can credit up to $3,000 in losses against ordinary income and can carry any leftover loss to future tax years.
Short-Term Capital Loss
A short-term capital loss is a loss on a property held less than one year. It can be used in the same way a long-term capital loss can be used. However, tax laws require long-term losses to be first credited against long-term gains and short-term losses to be credited against short-term gains before they are used as a credit against a gain in another category.
Mary Gallagher runs Mary Gallagher Planning (mgaplanning.com), an urban planning and consulting business in San Francisco. She is the former assistant planning director for San Francisco and planning director for San Mateo. Gallagher has been writing about real estate, development and land use for numerous websites since 1995. She holds a master's degree in historic preservation planning from Cornell University.