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-- Posted: March 10, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

How to figure capital gains

Dear Dollar Diva,
I own a duplex and live in one unit and rent out the other. I have owned this property for five years and want to sell it, but I am worried about paying capital gains. How is this figured?

When you sell your duplex, you'll have one closing for the sale of one piece of real estate. However, for tax purposes, the sale is looked upon as two transactions: the sale of your home and the sale of your rental property. Assuming you live in half the duplex and rent the other half, 50 percent of your gain on the sale of this duplex will be taxed as the sale of rental property.

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Sale of principal residence

You can exclude up to $250,000 in capital gains on the sale of your principal residence if you are single; $500,000 if you are married filing jointly -- if you have lived in it for at least two of the five years preceding the sale.

Hardly anyone pays capital gains on the sale of his residence if he's lived in it for more than two years, so you probably won't have to pay capital gains on that half of the sale. 

Sale of rental property

You have to pay tax on the sale of rental real estate, and you may need a tax professional to help you figure out how much. Generally, if you've used the straight-line method of depreciation, capital gains are figured by subtracting the cost of the property and the cost of selling it from it's sales price, and adding back the depreciation you took. However, if you've used an accelerated method of depreciation, the depreciation that exceeds the amount of depreciation you would have taken under the straight-line method is taxed at a higher rate.

Straight-line depreciation
Straight-line method of depreciation is the cost of the depreciable property divided by the recovery period as prescribed by the IRS. For example, residential buildings must be depreciated across 27.5 years, non-residential buildings across 39 years.

Accelerated depreciation
Accelerated methods of depreciation use a formula that provides a higher percentage of depreciation in the earlier years of the depreciable property's recovery period.

Form 4797, Sale of Business Property, is used to report the transaction, and the gain gets carried over to Schedule D, Capital Gains and Losses.

Part III of Form 4797 is where you figure out the capital gains. The form can be confusing. You'll need to know the following information:

  • Your rental is considered 1250 property. (The land under it is 1231 property.)
  • Half of the sale price, assuming the rental occupied half of it. At any rate, the price gets split proportionately.
  • How much you paid for it (50 percent, if the rental is half)
  • Cost of sale (50 percent of the real estate commission and other closing costs, if the rental is half)
  • How much depreciation you took and how much of it was accelerated depreciation

If you are in the 15 percent tax bracket, the capital gains will be 10 percent.  If you are in a higher tax bracket, it will be 20 percent.

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