How to Figure Capital Gain on a Rental House

Capital gains on the sale of a rental house can add up quickly with depreciation recapture.

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Capital gains are always figured in the year you sell or dispose of a capital asset. The Internal Revenue Service categorizes rental houses as income-producing business property. This excludes rental homes from the gain exclusion reserved for personal residence sales – even if you personally own the rental home.

Step 1

Calculate your income and expenses for the rental on Schedule E in the year of disposition. Even if you have no income for the property, you’ll still have a depreciation expense in the year of disposal. Depreciation expenses are recaptured to calculate capital gains regardless of whether you claim the expense, so you’ll want to ensure you get the benefit of the depreciation cost for the property.

Step 2

Calculate your basis for the rental house. If the house was always maintained as a rental, your cost basis equals the purchase price, plus improvements and non-deductible expenses you pay to secure the title to the property. If the rental was converted from personal use, your cost basis equals the fair market value of the house on the date of conversion, plus improvements made during the time the house was a rental.

Step 3

Add back depreciation expenses. When you sell rental real estate, you must recapture the depreciation you claimed, or were entitled to claim in previous tax years. If you used tax software or a professional tax preparer to prepare your last return, you should have a depreciation worksheet with your tax records. The worksheet lists your accumulated depreciation. Add your current year’s depreciation expense to the accumulated total from the year before. The result is the depreciation you must recapture.

Step 4

Add your recaptured depreciation to your basis. The result is your adjusted basis for the rental house.

Step 5

Calculate the sales price of the rental house. This includes the price you sell the property for, minus any expenses you pay to facilitate the sale, such as closing costs and cash to buyer. The result is your net sales price.

Step 6

Subtract your adjusted basis from the net sales price. If the result is positive, this is the amount subject to capital gains tax. If the result is negative, you may have a deductible capital loss.

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About the Author

With a background in taxation and financial consulting, Alia Nikolakopulos has over a decade of experience resolving tax and finance issues. She is an IRS Enrolled Agent and has been a writer for these topics since 2010. Nikolakopulos is pursuing Bachelor of Science in accounting at the Metropolitan State University of Denver.

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