San Francisco Apartment Association
SFAA Magazine Archives

January 2004

Debits & Credits

Calculating Real Estate Income Taxes

by Douglas Schultz & Alex Yarmolinsky

Q. How do I calculate my income tax from the sale of my residential rental real estate?
A. In order to calculate your income tax, we should divide the answer into two parts: first the calculation of the taxable gain and second the determination of the applicable tax rates.

How to Calculate the Taxable Gain

The basic formula for calculating the capital gain seems straightforward—the net selling price minus the adjusted basis equals the gain or loss. However, in order to determine what makes up the net selling price and the adjusted basis, we must define a few terms.

Net Selling Price

The net selling price is the current sales price, less any selling expenses.

  • The current sales price is usually found on the closing statement or real estate contract, which indicates the official sales price. This amount should represent cash received, plus the fair value of all other assets received. These include mortgages on the property assumed by the purchaser, the face value of any promissory notes accepted by the seller and the face value of any agreed-upon installment contract.
  • Selling expenses include any payments made by the seller for services required to market and sell the property, as well as to complete the sales transaction. These expenses include commissions paid to brokers, advertising, accounting fees related to the sale, escrow fees, appraisals, inspections, and other costs incurred to complete the transaction.

Adjusted Basis
The adjusted basis is the original cost basis, plus any improvements made, minus accumulated depreciation.

The original purchase price is usually indicated on the original purchase closing statement or real estate contract. However, as with the current sales price (above), the purchase price will be based on the value of all assets originally given by the buyer to the seller. In addition, the original cost basis may be different if the property was acquired via an exchange, a gift or divorce, or an inheritance.

  • Similar to selling expenses included in the net selling price (above), any closing costs that were incurred to purchase the property should be added to the basis. Some costs can even occur after the original closing. For example, the purchaser may have to buy out an existing lease on the property to complete the purchase, which would increase the cost basis.
  • Improvements are additional capital investments made to the property while you owned it. Basically, improvements are expenditures that add to the property’s value or increase its useful life.
  • Accumulated depreciation is the total cost recovered (in the form of depreciation expenses) over the useful life of all improvements made to the property.

Now that we have defined all that goes into calculating the net selling price and the adjusted basis, we can calculate the gain or loss on the property sold.

How to Determine the Applicable Tax Rates

For federal tax purposes, the rates on which the gain is taxed depend on the nature of the gain. Generally, the amount of the gain related to depreciation recapture (which is equal to the amount of accumulated depreciation taken on the property) is taxed at a rate of 25 percent, while the remaining gain is taxed at long-term capital gain rates. For individuals who have sold their property before May 6, 2003, the maximum long-term capital gain rate is 20 percent. For individuals who sell their property on or after May 6, 2003, through December 31, 2008, the maximum long-term capital gain rate is reduced to 15 percent.

California doesn’t have capital gain rates or depreciation recapture rates; therefore, any gain is taxable at your individual income tax rate. The maximum rate for individuals is 9.3 percent in 2003.

The opinions expressed in this article are those of the authors and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Douglas Schultz is a partner in the tax practice division of Burr Pilger & Mayer (BPM), a San Francisco-based accounting and tax consulting firm. Alex Yarmolinsky is a manager in the tax practice division at BPM, specializing in high net worth individuals, family limited partnerships, trusts, and real estate development. They can be reached at 415-421-5757. Copyright © 2004.