Most property an individual owns is considered a capital asset. When property is sold, the owner is said to acquire a capital gain or loss, in direct proportion to the original monetary investment as compared to the selling price. The sale of rental property is treated differently than other capital gains by the IRS, and the percentage of gain also varies depending on whether the property is residential, nonresidential or low-income housing. Once classified and calculated, a gain on the sale of rental property is treated as ordinary income and taxed at the "ordinary" rate.
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When selling rental property not considered a business property, an individual must file Schedule D (Capital Gains and Losses) of Form 1040 at tax time. A capital gain or loss on a sale of property is calculated by first determining the "basis" of the property. In addition to figuring gain or loss, for tax purposes, basis is the basic value used to figure depreciation. Unless the property was inherited or acquired as a gift, basis generally equals purchase price plus costs of improvements or minus depreciation. The IRS provides a specific worksheet to determine the amount of gain and thus "ordinary income."
During the process of selling a rental property, expenses incurred for "managing, conserving, or maintaining" the property while it is on the market are deductible. These expenses must be "ordinary and necessary," according to the IRS, and are treated differently under tax laws than improvements made to the property to increase the value and sale price. The costs of improvements should be recaptured through depreciation.
Declaring a Loss
If an owner's basis in a rental property is more than the selling price, a "recognized loss" may be incurred. This is reported on Schedule D of Form 1040 and is thus deducted from gross income on the 1040 tax form. The IRS requires a property owner to maintain accurate records to show the original purchase price of a rental property, receipts and documents pertaining to any improvements to the property, records of fees paid for surveys and recording a deed, transfer taxes and title insurance. The IRS also stipulates that gains and losses do not apply on property transfers between spouses or divorced spouses if the transfer is related to a divorce.
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