Investment properties can be a great source of income in stable and growing markets. However, in declining housing markets the sale of an investment property might result in a loss. This results in a tax implication called a capital loss, which can be deducted on your tax return. However, you cannot claim or deduct a loss on the sale of your primary residence or a property not used for investment purposes.
In the eyes of the government, investment properties are second -- or third, fourth and so on -- homes that you have purchased for the purpose of renting for a profit or fixing up and selling for profit. The Internal Revenue Service considers investment properties capital assets. The sale of your capital assets will result in a capital gain or loss. Both gains and losses must be claimed on your federal tax return on Form 8949. This form determines the bottom-line tax implication for which you will be responsible. It factors in the costs associated with the sale such as the adjusted basis cost and depreciation.
Selling an investment property for less than you paid for it or what it's worth is considered a loss. The basis of the property is used to determine the amount of the loss. Basis can be determined in a few ways; however, the cost basis and fair market value basis are common. The cost basis is simply the amount you paid for the property when you originally purchased it. If you didn't purchase the property, but perhaps received it as a gift, the basis can be determined by the fair market value. This is the price someone would be willing to pay for the property in a normal sale. The fair market value can be determined by a property appraiser.
The costs accumulated through the sale of your property can also be deducted, by subtracting them from the basis value. The specific sales contract will determine which party -- the seller or buyer -- pays what, and the HUD-1 settlement statement lists all of the amounts paid. Selling costs often include real estate agent commissions, advertising costs, transfer taxes and recording fees.
Capital Gains vs. Losses
At tax time, your capital gains and losses are reviewed and calculated. The gains are added together, and then any losses are subtracted. Your losses can offset your gains partially or fully. At the time of publication, if the loss amount is greater than the gain amount, up to $3,000 can be deducted from your other taxable income, such as the income earned from your regular job. If the net losses total more than $3,000, the additional amounts can be carried over into the following years.