Capital Gains question on free and clear rental property

Ok, this question was posed to me by a real estate broker, and I didn’t have an answer… Someone, please help. :slight_smile:

Do you have to pain Capital Gains tax on monthly rental income if you own a rental home free and clear??

gross monthly rental income is reported on SchE of your tax return. Net income of the property (after expenses) is then transfer to the income section of your 1040 (if a loss, that negative number may be limited). When you own free and clear only impacts if you report mortgage interest as any expense (on SchE) and thus impacts net income (or loss).

So, the simple answer is NO.

The simpler answer is NO. Net rental income is taxed as ordinary income at the taxpayer’s marginal tax bracket rate.

Capital gains only applies to profit realized on the sale of the property.

Just to be nitpicky about capital gains and real estate…

The straightline depreciation you’ve taken on a rental is capital gains but it’s taxed in a special way as unrecaptured Sec. 1250 gain (which means the lower of either a 25% tax rate or your ordinary income tax rate)…

The rest of the gain (also capital gain) is taxed at 15%… unless you’re in the lowest tax bracket in which case it’s taxed at 5%.


I can’t reconcile your comment with IRC Section 1(h)(1)(D). In my view, unrecaptured depreciation tax rate is 25% regardless of taxpayer’s marginal bracket.

I know that there is an IRS publication which says that the maximum rate on uncaptured depreciation is 25%, which implies that a lower rate may apply to the lowest tax brackets, but I don’t see this confirmed in the tax code.

I see that the tax code language is a bit obtuse, so would you please interpret this section of the tax code and tell me where I am going astray?

Think about it this way… assume you’ve got $8000 of unrecaptured Sec. 1250 gain…and no other income.

You’re not subject to income taxes at this income level if you’re, say, a single person using the standard deduction claiming a single withholding exemption.

Do you think that person pays $2000 of tax? Or $0…

I think zero.