If you own real estate that has been held for more than a year and sell it for a profit, you might expect to pay the typical 15% or 20% federal income tax rate that applies to long-term capital gains. This could also apply if your real estate ownership is through a pass-through entity like an LLC, partnership, or S corporation.
However, some real estate gains can be subject to higher tax rates due to depreciation deductions. Here’s a summary of the key federal income tax considerations that may apply to real estate gains:
Vacant Land
The current maximum federal long-term capital gains tax rate for selling vacant land is 20%. This rate only applies to high-income earners. For 2024, if you’re a single filer, the 20% rate kicks in when your taxable income, including any land sale gain and other long-term capital gains, exceeds $518,900. For married couples filing jointly, the threshold is $583,750, and for heads of households, it’s $551,350. If your income is below these thresholds, you won’t owe more than a 15% federal tax on the gain. However, the 3.8% net investment income tax (NIIT) may still apply to some or all of the gain.
Gains from Depreciation
Gain resulting from real estate depreciation using the straight-line method is categorized as unrecaptured Section 1250 gain. This type of gain is generally taxed at a flat 25% federal rate, unless a lower rate applies when included in your taxable income without special treatment. Additionally, you may owe the 3.8% NIIT on some or all of this gain.
Gains from Depreciable Qualified Improvement Property
Qualified improvement property (QIP) typically refers to improvements made to the interior of a nonresidential building after the building is placed in service. However, it does not include costs for building enlargements, elevators, escalators, or structural framework.
If you’ve claimed first-year Section 179 deductions or bonus depreciation for QIP, any gain up to the amount of the Section 179 deduction will be taxed as high-rate Section 1245 ordinary income recapture. This means the gain will be taxed at your regular income tax rate, rather than the lower long-term capital gains rate. The 3.8% NIIT may also apply to some or all of this gain.
If you’ve claimed first-year bonus depreciation for QIP, any gain up to the amount of the bonus depreciation deduction over what would have been allowed using the straight-line method will be taxed as Section 1250 ordinary income recapture. This gain is taxed at your regular income tax rate, and the 3.8% NIIT may apply.
Tax Planning Tip: If you choose to use straight-line depreciation for real property, including QIP, and do not claim first-year Section 179 or bonus depreciation deductions, you won’t face Section 1245 or Section 1250 ordinary income recapture. Instead, you’ll have unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%. The 3.8% NIIT may still apply to some or all of the gain.
Consider the Complexity
As you can see, the federal tax rules for real estate gains can be more complex than they initially appear. Different tax rates may apply to different types of gains, and you could also owe the 3.8% NIIT and possibly state income taxes.
At Accavallo & Company, we take care of all the details when preparing your tax return. Feel free to contact us with any questions specific to your situation.
