Capital Gains vs Annual Income

[wufibugs]

In 2023 I sold a long term rental property realizing substantial capital gains.  I understand capital gains are treated differently than income.  The law says I would pay no capital gains tax if my "income" is under $44,625.  However, if I enter the capital gain on the 2023 sale of the rental where indicated in Turbotax, it produces as  "income" my regular annual amount, which would be under $44000, PLUS the capital gain resulting in a very substantial capital gain tax burden.  

For all practical purposes if that is correct, the sale of business assets will ALWAYS result in lower income people having a substantial capital gain obligation unless the sale produced a minimal profit or a loss.  For lower income folks like me the $44000 dollar figure only rewards business failures and punishes the rare business success.

[KrisD15]

The reason is "Depreciation Recapture"

When you sell a rental, the depreciation you took and then recovered is reported as ordinary income. 

After that, profit is capital gain.

So if you purchase property for 220,000 and depreciate 150,000 it has an "adjusted basis" of 70,000.

If you sell it for 300,000 you would have 150,000 depreciation recapture (ordinary income) and 80,000 Capital Gain. 

It doesn't matter if you did not take deprecation, the IRS charges the depreciation recapture if you properly claim depreciation or not. 

[cynaguirre]

This is the issue I was having when doing my moms taxes.  She made $38,000 last year but she sold a rental property for $200,000 in 2023.  She acquired this property when my dad passed away in 2012  and the Fair Market Value was only $60,000.  So there was a capital gains of $140,000 plus her $38,000 income. She now has owes around $26,000 in taxes.  I applied for an extension because two different people from TurboTax told me to enter the sale in two different areas.  I am going to take the paperwork to a tax place.  

[Rick19744]

@wufibugs 

While you are not able to have zero capital gains tax rate, I'm fairly certain that you would be in the 15% tax rate; income doesn't exceed $492,300.

The law is designed to benefit those with very low income and when someone has a gain that is substantial, they no longer have low income.  Plus you have the cash to pay the tax.

So if you have a gain of $100,000, you will pay $15,000 netting $85,000.  That's a pretty good deal and I would take that all day long.

Your actual tax may even be lower depending on the facts.  This is due to the way the tax calculation works:

• Your tax on all taxable income is the smaller of:
• The tax on all your taxable income including the capital gain, or
• The tax on your regular income (without capital gains) plus the tax on your capital gains using the capital gains tax rate.