As I'm sure you're aware, you are required by law to depreciate rental property. Many incorrectly believe that depreciation is a permanent deduction from their taxable income. it is not.
Depreciation is a reduction of your cost basis. You are required to depreciate any property that is used to produce income. However, land is not depreciable. Only the value of the structure is depreciated.
So if you paid $100,000 for a rental property 10 years ago, that first year renting it out you would have been required to provide a value for the land that rental property sits on, and a separate value for the structure itself. So for this scenario lets say the land was valued at $30K and the structure was valued at $70K. That means you would be required to depreciation the $70K value of the structure over 27.5 years. Therefore over ten years you would have taken approximately $2,541 each year for a total of $25,410 over 10 years.
So after 10 years you sell the property for $90,000. You would think that since you purhcased it for $100,000 that would be you sold at a loss. But not so fast. That $25,410 of depreciation is subtracted from your cost basis of $70K on the structure. So you subtract the $25,410 of depreciation you took from your original $100K you originally paid for it, and you have an adjusted cost basis of $74.590.
So if you sold the property for $90K that means you have a taxable gain of $15,410
Now the above is an extremely simplistic scenaro. In reality, you may have property improvements that will increase the cost basis (which are depreciated also) as well as deductible things related to sales expenses and the such. For example, since rental property always operates at a loss on paper at tax time, in the year you sell you first deduct all your carry over losses from your taxable gain. So that reduces your taxable amount even more.
