When you sell an investment property, such as a duplex, Uncle Sam taxes you on your capital gain. This gain is the difference between your selling price and purchase price with some adjustments for various costs. In some real estate transactions, a buyer becomes responsible for an existing mortgage on a property. If this occurs when you buy or sell your rental property, you must include the loan amount in your capital gain calculation. If you pay off your mortgage when you sell your investment property, the loan does not affect your capital gain.
Add any closing costs you paid when you purchased the investment property. Such costs might include commissions, title fees or attorney fees. Exclude any costs to obtain a new mortgage, such as points. For example, assume you paid $10,000 in commissions and $2,500 in other closing costs. Add $10,000 and $2,500 to get $12,500.
Add your Step 1 result to the amount you paid for the property. If you took over an existing mortgage on the property, add the loan amount to this step’s result. If you obtained a new loan to buy the property, do not add the loan amount. In this example, assume you paid $100,000 cash and took over a $600,000 existing mortgage on the property. Add $12,500, $100,000 and $600,000 to get $712,500.
Find out the total depreciation you took on the property and the total amount you spent on capital improvements from your records. Depreciation is a tax deduction to account for wear and tear. A capital improvement is a permanent addition that increases the property’s value or extends its life. Such improvements might include a new bedroom or garage. In this example, assume you took total depreciation of $200,000 and spent $15,000 on capital improvements.
Add the total capital improvements to and subtract the total depreciation from your Step 2 result to figure your adjusted basis. In this example, add $15,000 to $712,500 to get $727,500. Subtract $200,000 from $727,500 to get an adjusted basis of $527,500.
Subtract any closing costs you paid when selling the property from the total cash you received from the buyer. If the buyer took over the existing mortgage on the property, add the loan amount to this step’s result. In this example, assume you paid $10,000 in closing costs, received $300,000 cash from the buyer and transferred a $500,000 mortgage to the buyer. Subtract $10,000 from $300,000 to get $290,000. Add $290,000 and $500,000 to get $790,000.
Subtract your adjusted basis in Step 4 from your Step 5 result to calculate your capital gain. A negative result represents a capital loss. Concluding the example, subtract $527,500 from $790,000 to get a capital gain of $262,500. This is the taxable portion of your sale. Your specific tax on this amount depends on various other factors.