If you own rental property and sell it during the tax year, you might want to consult with an accountant or tax professional when April comes around. Reporting the sale on your tax return isn't a task for the faint of heart – unless you have some tax savvy and experience. It involves multiple forms, and one of them has multiple, interchanging parts.
Calculating Capital Gain or Loss
Your first – and perhaps simplest – challenge is to determine whether you have a capital gain or capital loss on the sale. This depends on how much you sell the property for and your basis or carrying value in the property.
Add its purchase price to what you've spent on improvements, then subtract any depreciation you're entitled to claim. Compare the resulting number with the sale price. If the sale price is more, you have a capital gain. If it's less, you have a capital loss.
Sale of Rental Property: IRS Form 4797
The Internal Revenue Service considers rental property to be business property, so you can't just report the gain or loss on your Form 1040. You must also complete and file IRS Form 4797, Sales of Business Property. If your rental property is a home, it's a Section 1250 property, so you must complete Part III of the form to determine if you have a gain. Then enter the resulting number on line 32 on line 6 of Part I.
If you owned the property for more than a year before selling it, the process changes. In this case, you must separate the sale of the structure from the sale of the land. The sale of the land is noted in Part I, and you enter the sale of the structure there as well if you have a loss. But if you have a gain, the sale goes in Part II. If all this seems a little overwhelming, the IRS offers detailed instructions on its website.
Schedule D Basics
If you can get past Form 4797, the sailing becomes a little smoother. You must also file IRS Schedule D, Capital Gains and Losses with your return. If you reported a gain in Part 1 of your Form 4797, transfer that number to line 11 of Schedule D as a long-term capital gain. The IRS provides exact instructions for Schedule D, too. You can take a deep breath now – you're almost there.
After you complete Schedule D, the resulting number goes on line 16 of your 2020 Form 1040. The IRS occasionally changes where this information should be entered, so if you are filing for a year other than 2020, be sure to consult the instructions for that particular year's 1040 form.
There's a significant margin for error in all these calculations, even if you meticulously follow the step-by-step instructions provided by the IRS. Some premier versions of tax preparation software will do the calculations for you, but if you decide to take pen to tax form yourself, you might want to call an accountant and have a professional review your return for accuracy.