Step 1 and 2: Amount realized and adjusted basis
Amount realized = selling price − selling costs (commissions, attorney fees, transfer taxes, other closing costs). This is what you \"net\" from the transaction for tax purposes.
Adjusted basis = original purchase price + capital improvements − total depreciation claimed (\"allowed or allowable\"). Depreciation reduces your basis each year you own the property, even if you forgot to claim it.
Step 3: Total gain and how it splits
Total gain = amount realized − adjusted basis. This gain splits into two buckets: (1) Unrecaptured Section 1250 gain — equal to the depreciation claimed, taxed at up to 25%; and (2) Remaining long-term capital gain — the appreciation above original cost, taxed at 0%, 15%, or 20% based on your income.
Example: Paid $320,000, claimed $60,000 depreciation (adjusted basis = $260,000), sold for $450,000 with $15,000 selling costs (amount realized = $435,000). Total gain = $175,000. Recapture slice = $60,000 (taxed at 25% = $15,000 federal). Capital gain slice = $115,000 (taxed at 15% for a middle-income seller = $17,250). Total federal tax: roughly $32,250 — before the 3.8% NIIT and state taxes.
Step 4: State taxes and NIIT
Many states tax the full gain as ordinary income at rates up to 13.3% (California) with no special recapture cap. The federal 3.8% Net Investment Income Tax applies if your MAGI exceeds $200,000 (single) or $250,000 (married). Budget for these separately from the federal capital-gains estimate.
Frequently asked questions
What selling costs can I deduct from my taxable gain?
Real estate commissions, legal fees, title insurance paid by the seller, recording fees, transfer taxes, and other costs directly related to the sale reduce the amount realized and therefore the gain.
Does refinancing affect my taxable gain?
No. Taking cash out through a refinance is not a taxable event and does not change your basis or the gain at sale. Only capital improvements and depreciation change adjusted basis.
What if I sell at a loss?
A loss on a rental held for investment is deductible as a capital loss (or ordinary loss if sold to an unrelated party, depending on use), but passive activity loss rules may limit the deduction.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.