Capital Gains on Rental Property

Capital gains tax on a rental property sale is calculated by subtracting the adjusted basis from the amount realized at closing. Adjusted basis starts with the original purchase price, adds the cost of capital improvements made over the holding period, and subtracts the depreciation deducted on tax returns each year. Because depreciation lowers basis every year the property is held, a rental that has been owned for a decade or more often produces a larger taxable gain than the simple appreciation in market value would suggest. If the property was held longer than one year, the resulting gain is generally taxed as a long term capital gain at a federal rate of zero, fifteen, or twenty percent depending on the owner's total taxable income, and higher income owners may also owe the three point eight percent net investment income tax.

A separate rule applies to the portion of the gain tied to depreciation already claimed. This amount, known as unrecaptured Section 1250 gain, is taxed at a maximum federal rate of twenty five percent regardless of the owner's regular capital gains bracket. In practical terms, an Albuquerque, NM landlord who has depreciated a rental property for many years should expect that a meaningful slice of the sale proceeds will be taxed at this higher recapture rate before any remaining gain is taxed at the standard long term rate.

New Mexico does not have a separate capital gains tax rate. Instead, capital gains are included in ordinary taxable income and taxed under the state's graduated income tax brackets, which means the New Mexico Taxation and Revenue Department collects tax on the same gain that the Internal Revenue Service taxes at the federal level. For an Albuquerque, NM investor selling an appreciated rental, the combined federal and state liability, including depreciation recapture, can reduce net sale proceeds substantially compared to the gross sale price.

A properly structured 1031 exchange under Internal Revenue Code Section 1031 defers both the capital gains tax and the depreciation recapture when the rental property is exchanged for other real property held for investment or business use. Deferral requires that a Qualified Intermediary hold the sale proceeds so the seller never has actual or constructive receipt of the funds, and that the investor meet the forty five day identification deadline and the one hundred eighty day closing deadline for the replacement property. We help Albuquerque, NM rental owners estimate the tax exposure of a straight sale, compare it against a deferred exchange, and coordinate the mechanics if deferral is the better path.