How to Estimate Your Capital Gains Taxes

• To estimate your tax liability on a property, you have to know what the gain (profit) will be - it’s the difference between the net sales price and the adjusted basis of the property: 

  Original sales price
  +      Purchase expenses
  +     Capital improvements
  -     Depreciation taken
  =     Adjusted basis

• This information is usually calculated each year for your tax returns on a particular investment property, so looking at last year’s tax return to see the amount of annual depreciation will give you a good estimate. 
• Once you have your adjusted basis, estimating the capital gain is simple:

  Sales price
  -     Selling expense
  -     Adjusted basis
  =     Capital gain

• Your capital gain on a property has two components: actual gain and recapture of depreciation.  If you’ve never taken depreciation, your taxes will be approximately 20% of your capital gain (plus state taxes). 
• Most people, however, do take depreciation, and thereby reduce their adjusted basis.  As a result, their tax estimate will take in to account the higher tax rate on the recapture-of-depreciation portion of the gain.
• The recapture-of-depreciation consideration is important because most real estate investors don’t think in terms of adjusted basis.  They take significant depreciation over the years and then are shocked to discover just how much that will affect their capital gains.  In cases where the property value doesn’t appreciate, the tax liability is high because the adjusted basis remains low.
• Because recapture-of-depreciation is taxed at a higher rate (25%) than capital gain (20%), it’s an important factor when estimating taxes.
• In order to estimate your tax liability on the sale of real estate, all you need to know is the adjusted basis, the total depreciation taken, and the expected net sales price.  From there it’s easy to estimate what portion will represent capital gain and what will be taxed at the recapture-of-depreciation rate.
• Example: you’re selling a property you bought 15 years ago for $200,000, and you expect to sell for $300,000.  You’ve always taken the depreciation and the total for that is now $100,000, which means the adjusted basis is also $100,000.  Once you sell the property (setting aside selling expenses), your taxable gain is $200,000 (sale price minus the adjusted basis).  Since half the gain on your property is represented by recapture-of-depreciation, it’s taxed at 25%.  The remaining capital gain, meanwhile, is taxed at 20%.  If taxes weren’t deferred, that means you owe $45,000 in federal taxes. 

Disclaimer: This article is provided for information use only.  It does not take the place of an attorney, a tax advisor, or an accountant.  Always seek out the advice of a licensed professional before undertaking any significant change in your financial situation.