Q: I own a home in Oregon which has been used as a rental since 2003. A year ago I purchased a home in Sacramento. I have lost my job and I am considering selling the Oregon home and using the proceeds of the sale (approx. $200,000) to pay off my mortgage here in Sacramento. I understand that these proceeds will be treated as a taxable gain. What would my estimated tax to be paid on the investment be? Is there any way to reduce the taxes paid?
-- William, Sacramento
A: You will be subject to capital gains tax on the gain, if any, you earn when you sell your rental property.
The good news is that capital gains tax rates are currently favorable, e.g., 0%, if you are in the 10% or 15% income tax brackets, and 15%, if you are in the 25% or higher income tax brackets. The current rates, part of the Bush-era tax cuts, are set to expire at the end of 2012. If Congress does not make any changes, the capital gains tax rate will be 20%, effective January 1, 2013.
Don't forget that you will have to recapture any depreciation you wrote off since 2003, when figuring out your gain or loss.
The only way to avoid taxes would be to reinvest the proceeds in another rental property; this is accomplished via a 1031 exchange. Obviously, this will not work for you since you wish to use the proceeds to pay off your mortgage.
The best way to reduce your taxes is to make sure to account for all improvements you made to the property, when calculating your gain.
I recommend that you seek the help of a tax professional on this matter.