Capital gains tax is the amount levied on any increase in an asset’s value from the time of acquisition to the time of sale.
When real estate is sold, any increase in value may be subject to capital gains tax. But the appreciation of an asset is not taxable until the asset is sold.
The basic formula is:
Capital Gain = Sales Price – Cost Basis
Cost Basis = Purchase Price or Fair Market Value + Improvements – Depreciation
If the sale nets a negative number in the above equation, it is called a capital loss (which can be used to offset any capital gains).
For inherited or gifted real estate, the fair market value of the property is used in the calculation in lieu of the purchase price. The purchase price (or fair market value) of the property at the time of acquisition must be adjusted, to calculate the cost basis. The costs of any improvements must be added. And any depreciation taken must be subtracted.
Tax rules differ between an income property and a personal residence. For example, a private home cannot be depreciated but is subject to a $250,000 or $500,000 capital gains exemption.
If the closing date for the sale of the real estate is one year or less from the date of acquisition, the capital gain is deemed short-term. A long-term capital gain can only result from property held for more than one year.
Short-term capital gains are taxed as ordinary income. Long-term capital gains have a lower tax rate than do short-term capital gains.
Federal tax rates for capital gains are consistent from state to state. But state tax rates for capital gains vary by state.