Estimating Your Tax Liability

Estimating Your Tax Liability

The Estimating Your Tax Liability It doesn’t take a CPA to estimate the potential tax liability on the sale of real estate. The math is fairly straightforward, but you have to know the three key factors previously described: the adjusted basis, the total depreciation taken, and the expected net sales price. From there you will be able to estimate what portion will represent capital gain and what portion will be taxed at the higher recapture-of-depreciation rate.

Example:
Tom has a rental property he has owned for 15 years. He originally paid $200,000 for the property, and it now has an expected sales price of $300,000. He has been depreciating the property for the full 15 years and his total depreciation taken to date is $100,000. His adjusted basis is now $100,000. If he sells the property, his taxable gain setting aside selling expenses, would be $200,000 (sales price less adjusted basis: $300,000 − $100,000 = $200,000). One-half of the total gain on Tom’s property is represented by recapture of depreciation and is therefore taxed at the 25 percent rate, and the remaining capital gain would be taxed at 20 percent, as shown in Figure 3.2. Thus, if the taxes were not deferred on the sale of this property, Tom would owe $45,000 in federal taxes. In the example above it is easy to see that the tax consequences of selling Tom’s property are significant. If this property were located in California or another state with similar state tax rates, the total state and federal taxes could be approximately $63,000 ($45,000 federal plus $18,000 state).

Estimating Your Tax Liability

A side note: If you buy into all the political posturing about eliminating federal capital gains taxes, remember that recapture of depreciation is still going to incur a 25 percent tax rate and state capital gains taxes will still apply.

So in the above California example, even with full elimination of a federal capital gains tax, there would still be approximately $43,000 in tax liability because of the tax on recapture of depreciation and the state-level capital gains tax.