There are lots of ways you can reduce your tax liability on capital gains realized from sale of a rental property. These will require you keep all records from the original purchase of the property and a detailed accounting of all expenses you incurred related to the property. You’ll also need a good tax advisor.
Deduct Your Property’s Depreciation
Rental property depreciation is a basic accounting principle that allows you to deduct the cost of a rental property over a set period of time. The IRS assumes a rental property will lose a certain amount of value every year (typically 3.6%). For as long as you own the property, this loss, also known as depreciation, can be subtracted from your taxable income every year. This, in turn, can lower your taxes and may even drop you into a lower tax bracket. If you own a rental property, the federal government allows you to claim the depreciation of the property every year for 27.5 years.
Deduct Qualified Expenses
You can earn tax deductions for all qualified expenses on your property, including mortgage interest payments, maintenance, insurance, travel, professional services, eviction-related expenses and more.
Increase Your Property Basis
The property basis is the amount of your capital investment in the asset for tax purposes. To determine the basis of your property, begin by noting the cost of the original investment that you made in it. Next, add in the cost of major improvements (for example, additions or upgrades). Then, subtract any amounts allowed via depreciation or casualty and theft losses. There are any number of capital improvements you can make over time to bring up the basis.
Here's an example of how increased basis reduces your tax. Say you buy a property for $100,000, keep it for 10 years and are about to sell it for $300,000. That would qualify as a long-term capital gain of $200,000. However, if you have detailed, documented evidence that you have made $125,000 in capital improvements to the property, your capital investment is effectively $225,000. Your capital gain is now reduced to $75,000.
