Capital Gains Question

[umterp1999]

If you sell a rental property, do you pay capital gains on the equity or on the price increase from purchase to sale?

[Samsam]

I think it depends what you plan to do with the money.  I just read about the 1031 Property Exchange.  Here is a link: http://en.wikipedia.org/wiki/1031_exchange

Under Section 1031 of the United States Internal Revenue Code (26 U.S.C. § 1031), the exchange of certain types of property may defer the recognition of capital gains or losses due upon sale, and hence defer any capital gains taxes otherwise due.

So I think if you are going to use the money to buy another investment property you are not taxed on the gains (although I think that is for a certain amount of time).

[arebelspy]

Doesn't the 1031 only apply to primary residences?

No.

[Kriegsspiel]

Damn man you are fast, I was about to delete it!

[arebelspy]

If you sell a rental property, do you pay capital gains on the equity or on the price increase from purchase to sale?

The latter, is the closest simple answer.

What happens is you have a "cost basis" that was established when you purchased it.  Then you take depreciation, which lowers your cost basis.  Then you can do improvements which can increase your cost basis.  Many things can move that cost basis around (which was initially established by the purchase price).  When you sell it, you pay gains on the sale price (minus deductible things like selling costs) minus that cost basis.

Feel free to ask any questions if that didn't make sense.

As an aside, yes you can 1031 into a like investment, but that just defers the tax, you keep your original cost basis.  Sometimes it gets messy.

[umterp1999]

Thanks for the information!

[Hamster]

The only things to add to what Arebelspy said:
-The depreciation recapture portion may be taxed at a higher rate (25%) than the rest of the capital gains.
-You may also see a tax reduction when you sell if you had unclaimed losses carried over from prior years
-If you keep the property and pass it to your estate (or if you do a 1031, and that property is eventually passed to an estate), then, if I'm not mistaken all the capital gains can magically disappear when it goes to your heirs, up to 1.3 million. I may be wrong as all this estate tax stuff keeps changing, and I'm planning to live for at least 50 more years so I don't watch it that closely...

[arebelspy]

The only things to add to what Arebelspy said:
-The depreciation recapture portion may be taxed at a higher rate (25%) than the rest of the capital gains.
-You may also see a tax reduction when you sell if you had unclaimed losses carried over from prior years
-If you keep the property and pass it to your estate (or if you do a 1031, and that property is eventually passed to an estate), then, if I'm not mistaken all the capital gains can magically disappear when it goes to your heirs, up to 1.3 million. I may be wrong as all this estate tax stuff keeps changing, and I'm planning to live for at least 50 more years so I don't watch it that closely...

Good point on #1.  On #2, this is true, however you'd better be planning ahead and essentially setting it aside, unused depreciation is usually if you make > 150,000 (there is a method to do this - consult a knowledgeable CPA). On #3, that's correct, heirs inheret on a "stepped up" basis that sets a new cost basis for them.

Thanks for the clarifications.  I'm sure there's still lots of stuff we missed, this was just a broad description, so definitely use a professional if it gets messy.  :)