Calculating Capital Gains Tax

Capital gains tax is based on the adjusted basis in the property. The taxable gain or loss from the sale of the property is the difference between the net sale price and the adjusted basis of the property.

Taxable Gain (or Loss) = Net Sale Price – Adjusted Basis

Therefore, anything that increases adjusted basis reduces the taxable gain on a sale, and anything that reduces adjusted basis increases the taxable gain on a sale. The present tax law includes penalties (recapture) for using the MACRS on real estate that taxes part or all of the capital gain as ordinary income when the property is sold.

Recapture is an income tax term that describes the retaking of the value (for IRS purposes) that was cost-recovered during the time that the asset was held. Recall the example just discussed of the residential building with an original basis of $1,300,000 and adjusted basis of $1,181,818. Assuming it had appreciated by $250,000 in six years, the taxable gain (exclusive of sales costs and fees) would be the difference between the new value of $1,550,000 and the book value of $1,181,818. The depreciation amount taken over the six years is thereby recaptured and subjected to taxation upon the sale of the asset.

Under current law, real estate gains are taxed at two different capital gain rates when a property sells for more than its original purchase price plus any capital improvements:

1. All of the capital gains attributable to cost recovery deductions are taxed at 25%. For most real estate: adjusted basis + cost recovery = original purchase price.
2. Any remaining gain, that is, everything above the original purchase price, is taxed like other long-term capital gains, at a rate of 15% for all but a few investors