When selling your rental property, it is essential to report the sale accurately. Please do so to avoid an incorrect tax payment or even a penalty assessment. Planning for the transaction before it occurs will ensure proper reporting and avoid costly penalties. This article guides how to report a rental property sale.
Special situations to report the sale of rental property on tax return
You must know the tax implications if you plan to sell your rental property this year. The tax burden varies depending on several factors, so it is best to get the advice of a tax expert specializing in business taxes. You can sometimes claim an exemption of up to $250,000 from selling your rental property.
There are also special rules governing capital gains and losses related to the sale of rental property. Gains are profits from selling real estate assets, and losses result from non-profitable transactions. If the property is received as a gift or an inheritance, special rules apply to the basis of the gain or loss.
Unlike a sale of a primary home, the sale of a rental property is a business asset and must be reported to the IRS. Capital gains taxes are due on this sale, just like sales of stocks, ETFs, and other business assets. For this reason, hiring an accountant with expertise in business accounting is a good idea. If you need help proceeding, you can also try 1-800Accountant, a tax preparation service specializing in small business accounting.
Calculating capital cost
There are three ways to calculate the capital cost of a rental property when reporting the sale on a tax return. In addition to Class 1, you can also include a leasehold interest, which is the interest of a tenant in leased tangible property. This type of interest is included in Class 1, Class 6, and Class 13.
In determining the capital cost of rental property, you need to know whether you own rental properties separately classified. If the price of a rental property is over $50,000, you will need to include it in a separate class. This will result in the cost of the rental properties being listed separately in the Area A calculation table.
Your cost basis is the amount you paid for the property plus any expenses you incurred to purchase it. The cost basis also includes any money you borrowed to buy the property. If the property was given to you, inherited, or traded, there are special rules that apply. For example, if the rental property was given to you by a generous person, you will have to use the basis of the great soul who gave it to you.
Expenses that are deductible as capital include standby charges, guarantee fees, and service fees. Moreover, you may be able to deduct interest on loans you took. However, the fees and costs of legal services that you incur for purchasing the rental property cannot be removed from the gross rental income.
Despite its importance, the primary purpose of purchasing a rental property is to make a profit. You can earn a significant return by investing money in this property. You can buy long-term tenants or flip them depending on your investment strategy.
Deducting costs
When you sell a rental property, you can often deduct closing costs from your taxable net income. These costs include real estate commissions, transfer taxes, title insurance, and deed recording fees. These costs amount to about 8% of the sale price. If you sold a rental property for $150,880, you could deduct $13,120 from your taxable income. This is a small amount to remove, but it can help your bottom line.
In addition to these costs, you can deduct the interest you pay on your mortgage and interest paid on credit cards. However, avoid mixing business and personal expenses when you file your taxes. Additionally, you can deduct petty cash expenses, such as food, parking, and printing documents. You should keep track of these expenses, whether they are related to your rental property. The good idea is to use vouchers to track your expenses.
The cost of cleaning and maintaining a rental property can also be deducted. However, any improvements that you made to the property must be depreciated. A good rule of thumb is to budget for 1% of the property value maintenance costs. For example, if your rental property is worth $300,000, you would need to spend approximately $3,000 on annual maintenance costs. You can save this money for future years.
In addition to these expenses, landlord insurance premiums can also be deducted. This insurance helps protect you in case a tenant fails to pay rent. A reputable provider for this type of insurance is Steady.
Avoiding capital gain or loss
There are two ways to minimize the impact of capital gains and losses on your rental property tax return. One is a 1031 exchange, which involves selling an investment property and using the proceeds to purchase a similar one. This strategy can help you indefinitely defer the capital gain or loss tax liability.
Another way to avoid capital gain or loss on your rental property tax return is to maximize your cost basis. Your cost basis is the price you paid for the asset, including renovation costs. It is essential to keep your receipts when you renovate or sell a rental property. Adding up all of these expenses will lower your capital gain or loss.
Another way to reduce the impact of capital gains and losses on your rental property tax return is to plan and sell the additional property. Then, move into the rental property for at least two years before selling it. This will minimize the capital gain or loss you will have to pay in taxes. If you sell a rental property in less than two years, you will not be able to deduct depreciation on the rental property.
Another way to avoid paying taxes on a rental property is to use the proceeds from the sale of your primary residence instead. This strategy will save you much more money on your tax return than selling your rental property. The IRS allows a married couple to deduct up to $250,000 in profits from selling their primary residence.
Real estate can be lucrative, but only after taxes are paid. If you are not prepared, you could end up with a tax bill that can be as high as 18% of your profits. You’ll maximize your investment and enjoy a greater return than CDs or low-yield savings accounts by ensuring you are ready for this tax return.
Capital loss harvesting
Capital loss harvesting reduces your tax bill by using a capital loss to offset capital gains. This method works by selling securities at a loss and using the proceeds to offset short-term capital gains. Short-term capital gains are taxed at a higher rate than long-term capital gains. In some cases, capital loss harvesting can help you save money in the long run.
Realized capital losses are often used to offset realized capital gains. This can significantly reduce your future tax liability by up to $3,000 annually. It can be beneficial during years when capital gains are significant. TDAIM’s tax advisors review client portfolios daily to identify opportunities to realize capital losses that can reduce your taxable income. The agency can also help clients learn yearly losses to offset capital gains.
A mutual fund or individual stock holding may have lost $15,000 or more over the past six months. John chooses not to harvest these losses. He now faces a tax liability of $9,900. On the other hand, Jane decides to gather the losses and reduces her tax bill by $3,450. This technique would benefit John and Jane from capital loss harvesting in future years.
Another method of capital loss harvesting is selling real estate and exchanging it for a different piece of income-producing real estate. Under the Section 1031 “like-kind exchange” process, the owner can defer capital gains on the sold rental property for as long as they continue to hold onto the substitute property. While this strategy may benefit some, it’s only applicable to some investors.
