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Mr. Feichthaler:
I bought a property back in 2009 and have been renting it out. I have decided to sell given the strong demand for rental properties like this. Will I pay income tax on the entire sales price?
-- Jason D.
Dear Jason:
Although more of a tax question than a real estate question, this is a good one. The income tax treatment of a sale impacts every person or company that sells a house, lot or commercial building. I have previously discussed the favorable income tax treatment for sale of primary residence, so this answer is limited to your question on the sale of a rental property.
The amount you paid for the property is called "basis" or "tax basis." There are certain amounts that can be added to that amount, like when a pool or an addition is built. Items like maintenance cannot be deducted from basis. Many individuals will depreciate the value of the building over time, which provides an annual income tax benefit. If you have done this, then the amount you depreciated the property needs to be deducted from basis. This will lead to the overall amount the IRS will consider that you paid for the property.
Then, we take the sales price, minus the costs of the sale, to determine the proceeds from the sale.
To answer your question, your income tax rate should not apply to the entire amount of the sale. Rather, tax is paid on the profit only, or the difference between the tax basis (amount paid) and the proceeds from the sale. Income tax for rentals properties can be complex, and I recommend you seek the advice of a CPA for filing annual returns and the return for the sale year, unless you already have one. I have found the small investment in reporting income correctly is well worth the peace of mind, and my clients have also found that the costs in time and money to defend against the IRS are terribly high.
Best of luck in getting a great sales price for your property!
Eric P. Feichthaler has lived in Cape Coral for over 33 years and graduated from Mariner High School in Cape Coral. After completing law school at Georgetown University in Washington, D.C., he returned to Southwest Florida to practice law and raise a family. He served as mayor of Cape Coral from 2005-2008, and continues his service to the community through the Cape Coral Caring Center, Cape Coral Historical Museum, and Cape Coral Kiwanis. He has been married to his wife, Mary, for over 20 years, and they have four children together. He earned his board certification in Real Estate Law from the Florida Bar. He is AV Preeminent rated by Martindale-Hubbell for professional ethics and legal ability, and is a Supreme Court Certified Circuit Civil Mediator. He can be reached at eric@capecoralattorney.com, or 239-542-4733.
This article is general in nature and not intended as legal advice to anyone. Individuals should seek legal counsel before acting on any matter of legal rights and obligations.