Understanding tax obligations—including federal and state capital gains, depreciation recapture, and transfer taxes—is crucial for strategic financial planning. Below is a comprehensive breakdown of the potential taxes you may face.
Investment Property Tax Overview
Multiple tax obligations apply when selling investment property, potentially reducing your proceeds by 30% or more. Strategic tax planning, including 1031 exchanges, can help defer these taxes and maximize your investment returns.
Federal Tax Obligations
- • Capital gains tax (0-37% rates)
- • Depreciation recapture (25% rate)
- • Net Investment Income Tax (3.8%)
State and Local Taxes
- • State capital gains tax (varies by state)
- • County transfer taxes
- • City transfer taxes
The Five Major Tax Categories
Federal Capital Gains Tax
Short-Term Rate
10% to 37% (ordinary income rates)
Long-Term Rate
0%, 15%, or 20% (preferential rates)
Based on holding period and income level
Net Investment Income Tax (NIIT)
Short-Term Rate
3.8% additional tax
Long-Term Rate
3.8% additional tax
Applies if MAGI exceeds $200K (single) or $250K (married)
State Capital Gains Tax
Short-Term Rate
Varies by state
Long-Term Rate
Varies by state
California: 1% to 13.3% as ordinary income
Depreciation Recapture Tax
Short-Term Rate
25% federal rate
Long-Term Rate
25% federal rate
Required recapture of claimed depreciation
Property Transfer Taxes
Short-Term Rate
County and city level
Long-Term Rate
County and city level
Varies by location, typically $1.10 per $1,000
1. Federal Capital Gains Tax
Short-Term Capital Gains Tax (STCG)
Applies to properties held for less than one year
Profits taxed as ordinary income: 10% to 37% based on income bracket
Long-Term Capital Gains Tax (LTCG)
Applies to properties held for more than one year
Preferential rates: 0%, 15%, or 20% depending on taxable income
2. Net Investment Income Tax (NIIT)
This is an additional 3.8% tax on investment income, including capital gains from property sales.
NIIT Income Thresholds:
- • $200,000 for single filers
- • $250,000 for married couples filing jointly
4. Depreciation Recapture Tax
If you have claimed depreciation on your rental or investment property, the IRS requires you to "recapture" that depreciation when you sell.
Fixed Rate: This recaptured amount is taxed at a fixed federal rate of 25%
Tax Calculation Example (California)
Let's illustrate the total tax burden with a hypothetical scenario:
Property Details
Purchase Price: $500,000
Sale Price: $2,000,000
Depreciation Claimed: $363,000
Total Capital Gain Calculation:
$2,000,000 - $500,000 = $1,500,000
Tax Breakdown with Calculations
Depreciation Recapture
$363,000 × 25% = $90,750
Federal Capital Gains
$1,500,000 × 20% = $300,000
Net Investment Income Tax
$1,500,000 × 3.8% = $57,000
California State Tax
$1,500,000 × 13.3% = $199,500
Total Tax Liability
$90,750 + $300,000 + $57,000 + $199,500 = $647,250
In this example, the total tax burden amounts to over 30% of the sale price, highlighting how significantly taxes can impact an investor's profit.
Ready to Minimize Your Tax Burden?
Schedule a free consultation to explore 1031 exchange strategies that can defer capital gains and depreciation recapture taxes.
Schedule Free ConsultationInvestment Property Tax: Frequently Asked Questions
Conclusion
Taxes on the sale of a property can be a complex and substantial financial obligation. Strategic tax planning is essential for maximizing your investment returns and building long-term wealth.
By understanding these various taxes, investors can work with a tax advisor to explore options like a 1031 exchange, which allows for the deferral of these capital gains and depreciation recapture taxes, enabling them to reinvest their full equity and maximize their portfolio growth.
