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Gain on Sale

Computing Tax on Gain on Sale of Depreciable Realty by an Individual - April 2012
Richard Scrivanich - Partner

Dear Client:

Generally, the gain from the sale by a noncorporate taxpayer of real estate that is a capital asset (or is used in a business) and is held more than 12 months isn't taxed at a rate higher than 15%. But a more complex set of rules comes into play when the asset sold is depreciable real estate. This is so because, in that case, a maximum rate of 25% will apply to what's called unrecaptured section 1250 gain and a maximum rate of 15% will apply to the balance of the gain. “Unrecaptured section 1250 gain” refers to the portion of gain that is eligible for capital gain treatment even though it is attributable to previously allowable depreciation. A further complication is that the portion of the gain that is unrecaptured section 1250 gain depends, as shown below, on when the property was placed in service.

Property placed in service after 1986. For real estate placed in service after 1986, all depreciation deductions allowable before the sale of the real estate give rise to unrecaptured section 1250 gain. Thus, if you sell, at a gain of $200,000, a building on which $90,000 of depreciation deductions were allowable to you through the time of sale, $90,000 of the gain is unrecaptured section 1250 gain that will be taxed at a rate of 25%. The remaining $110,000 of the gain will be taxed at a rate of 15%.

Property placed in service before 1987 and after 1980. For real estate placed in service before 1987, but after 1980 (pre-1987 realty), the treatment of gain on sale depends on whether the real estate is residential or nonresidential.

Residential real estate. The applicable rules are the same as for a sale of post-1986 property, but because, under the pre-'87 depreciation rules, the property will be fully depreciated by the time of sale, all sales proceeds not in excess of the original cost are taxed at a rate of 25%, and only any appreciation is taxed at a rate of 15%.

Nonresidential real estate. If you depreciated nonresidential pre-1987 realty using just straight-line depreciation, the tax results will be the same as for residential real estate. But if, as was possible, you, at any time, used a declining balance method to depreciate the realty, the gain on sale will be taxed as follows:

  • gain, to the extent of the depreciation allowable to the time of sale, will be recaptured as ordinary income, and, thus, taxed at ordinary income rates; that means that because, under the pre-'87 depreciation rules, the property will be fully depreciated by the time of sale, all sales proceeds not in excess of the original cost will be taxed at ordinary income rates.
  • any appreciation is taxed at a rate of 15%.

    • Pre-1981 property. The following rules apply if you sell real estate placed in service before 1981:

  • the excess of depreciation claimed over straight-line depreciation is recaptured as ordinary income, and, thus, taxed at ordinary income rates (but the amount of excess depreciation subject to recapture may be less for certain residential real estate or for real estate acquired before 1970).
  • gain, to the extent of the balance of depreciation allowable, is unrecaptured section 1250 gain, taxed at a rate of 25%.
  • the balance of the gain, if any, would be taxed at a rate of 15%.

If you have any questions regarding the above discussed topic or any other tax matter, please feel free to give me a call at (562) 698-9891.