When selling a home, you normally don't think about paying income taxes. Money you make from selling your own home isn't usually taxable unless you make an enormous capital gain. But rental houses are another story. The taxing authorities want a bite of any profit you make on the sale of most rental properties. In many cases, you'll even owe taxes if you sell the property for less than what you originally paid.
Whenever you sell property for more than you paid for it, you've made a capital gain, and it's usually taxable. In the case of a rental house, your capital gain is the sales price minus your "cost basis," which is what you paid for the house plus the cost of any improvements, minus any depreciation you took or could have taken on the house. So if you bought the house 10 years ago for $100,000, spent $10,000 fixing it up, but claimed -- or could have claimed -- $30,000 in depreciation over the past 10 years, your cost basis is $80,000. If you sell the house for $110,000, your capital gain is $30,000.
Personal Home Exception
If the rental house used to be your personal residence, you may not be required to pay taxes on the sale. You can make up to $250,000 tax free from the sale of your main home, or $500,000 if you file jointly with your spouse, if you both lived there for the requisite number of years. For the rental house to be considered your home under this rule, you must have owned and lived in the house for two of the previous five years. You can only claim this exemption once every two years, so if you recently sold another house, you might not qualify.
You can also avoid the capital gains tax if you use the money from the rental house to purchase another rental property. This is known as a like-kind exchange and involves some complicated paperwork, so it's usually best to let a professional handle the details. Even if you avoid taxes now with a like-kind exchange, the taxes probably will catch up to you when you sell the second property.
If you had carry-over rental expenses that you could not claim in previous years because they exceeded your rental income, you can claim those losses in full on Schedule E the year you sell the home. Also, if you sell the house for less than your basis in the home, you can claim a capital loss on Schedule D and apply up to $3,000 of the loss against your other income. Any amount over $3,000 can be deducted in future years, at a rate of $3,000 per year.
Use Schedule D to report capital gains and losses on rental property. If you owned the property for a year or less, any profit will be taxed as regular income. But if you owned the property for more than a year, it is considered a long-term capital gain and may receive more favorable treatment. Long-term capital gains in 2013 are taxed at a lower rate than other income.
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