Selling a rental property

Most writing about home sales leans on the Section 121 exclusion, and most of it therefore does not apply to you. A property that was never your principal residence gets no exclusion at all— there is no $250,000, no $500,000, and no threshold below which the question goes away.

Which means basis is not a detail here. It is the whole calculation.

No exclusion, so basis is everything

Gain on the sale is broadly the amount realised less your adjusted basis (Publication 544). With no exclusion sitting in front of it, every dollar of adjusted basis you can support is a dollar of gain that is not there.

For a homeowner, poor records may cost nothing, because the exclusion often absorbs the difference. For a rental, poor records cost the full amount, every time. There is no cushion.

Depreciation cuts both ways

Rental property is depreciated over its recovery period, and that annual deduction is one of the reasons the arithmetic of holding rentals works (Publication 527).

But depreciation reduces your adjusted basisas you take it. So the deduction you enjoyed each year quietly raises the gain you will eventually report. That is not a trap — it is the design, a deferral rather than a forgiveness — but people are frequently surprised by the size of it after a long hold.

This is why a long-held rental can show a large taxable gain even where the sale price is close to what was paid. The basis has been ground down by fifteen or twenty years of depreciation while the purchase price stayed where it was.

Recapture is owed either way

On sale, depreciation allowed or allowable is generally recaptured and taxed as unrecaptured Section 1250 gain, at a rate of up to 25% — separately from the rest of the gain.

Note allowable. If you were entitled to depreciate the property and did not claim it, the recapture calculation can still be based on the amount you could have taken. Not claiming it is not a way out; it is a way to pay the tax without having had the benefit. If that describes you, it is a conversation to have with a tax professional early, not at closing.

Improvements made during the rental period are treated differently from ordinary repairs — broadly, an improvement is added to basis and depreciated, while a repair is generally deducted in the year it is incurred. The distinction is the same one homeowners face, but here it affects both the annual return and the eventual sale.

The records that decide it

For a rental the file needs more than receipts. It needs dates and a history:

• The purchase documents, and the allocation between land and building — land is not depreciated, and that split follows the property for its whole life
• The depreciation schedule: what was taken each year, under what method, and what was allowable
• Improvements with dates, separated from repairs, since each has its own treatment and its own schedule
• Any period the property was nota rental — vacant, personal use, or your own residence — because each changes the treatment for that stretch
• Casualty losses, insurance payments, credits and rebates, all of which generally reduce basis

If the property was ever your home as well as a rental, the rules interact in ways that depend on the order of events rather than the totals. That case has its own article.

There are also structures — a like-kind exchange being the common one — that can change the timing of all of this. They have strict requirements and are firmly a matter for your tax professional. What they do not change is the need to know your basis: an exchange carries basis forward, so poor records follow you into the next property rather than being left behind with the old one.