Do I Owe Capital Gains Tax on a Converted Rental Property?

Question from jim, Do I Owe Capital Gains Tax on a Converted Rental Property?

Answer from AI:

When you sell a property that has been converted from a personal residence to a rental property, the tax implications can be complex. Here’s a general overview of what you might expect regarding capital gains tax, both federally and at the state level in California.

Federal Capital Gains Tax

The federal government taxes capital gains, which are the profits from the sale of an asset like real estate. The rate at which these gains are taxed depends on your income and how long you’ve owned the property. Since you’ve owned the property for more than a year, it would be considered a long-term capital gain, which typically has lower tax rates than short-term gains.

However, there are some specific rules for properties that have been both personal residences and rental properties:

• Section 121 Exclusion: The IRS allows you to exclude up to $250,000 of capital gains from the sale of a personal residence if you’ve lived in the home for at least two of the five years before the sale. This is known as the Section 121 exclusion. However, since your property has been a rental for the past 10 years and not your primary residence for at least two of the last five years, this exclusion may not apply.
• Depreciation Recapture: If you’ve claimed depreciation on the property while it was rented, you may have to pay a depreciation recapture tax at a 25% rate on the amount of depreciation claimed when you sell the property.

California State Capital Gains Tax

California treats capital gains as regular income, so they are taxed at the state’s ordinary income tax rates. There are no special rates for capital gains in California, and the state does not offer a Section 121 exclusion. Therefore, any capital gains from the sale of your rental property would be subject to state income tax.

Income Considerations

Since you mentioned that your income is primarily from social security, it’s important to note that capital gains could potentially affect the taxability of your social security benefits. This could increase your overall tax liability.

Non-Rental Period

The fact that your property has not been rented for the past 18 months due to refurbishment may not significantly impact your capital gains tax liability, but it could affect the calculation of depreciation recapture if you’ve continued to depreciate the property during this period.

Seeking Professional Advice

Given the complexity of your situation, it is highly recommended that you consult with a tax professional or a certified public accountant (CPA) who can provide personalized advice based on the specifics of your case. They can help you understand:

• The precise capital gains tax rate that would apply to your sale.
• Any possible tax deductions or credits for which you may be eligible.
• Strategies for minimizing your tax liability.

For more information on federal capital gains tax, you can visit the IRS Topic No. 409 on Capital Gains and Losses. For California state tax information, you can refer to the California Franchise Tax Board.

Please note that this information is not legal or tax advice. Tax laws are complex and change frequently, and your specific circumstances can significantly affect your tax liability. Always consult with a professional for accurate and personalized advice.