Capital Gains Tax on Rental Property

When a Jacksonville, Florida investor sells a rental property for more than its adjusted cost basis, the difference is a capital gain, and the Internal Revenue Service treats that gain as taxable income in the year of sale. Adjusted cost basis starts with the original purchase price, adds the cost of capital improvements such as a new roof or a renovated unit, and then subtracts depreciation claimed over the holding period. Because depreciation lowers the basis every year the property is held, long-term rental owners in Duval, Clay, St. Johns, and Nassau counties often discover that their taxable gain is larger than the increase in the property's market value would suggest.

Two separate taxes typically apply to the sale of a rental property. The first is capital gains tax on the appreciation itself, assessed at the long-term rate for property held more than one year, which currently tops out at twenty percent at the federal level for higher-income sellers, plus a potential three and eight-tenths percent net investment income tax. The second is depreciation recapture, which taxes the portion of the gain attributable to depreciation deductions at a maximum federal rate of twenty-five percent, regardless of the seller's regular income tax bracket. Florida does not impose a state income tax, so Jacksonville-area investors avoid a layer of state-level capital gains tax that sellers in many other states must pay, but the federal liability still applies in full.

A Section 1031 exchange is the primary tool available to a rental property owner who wants to sell an investment property and reinvest the proceeds without triggering either the capital gains tax or the depreciation recapture tax at the time of sale. To qualify, the relinquished property and the replacement property must both be held for investment or business use, the investor must use a Qualified Intermediary to hold the sale proceeds, and the investor must identify replacement property within forty-five calendar days of closing and complete the purchase within one hundred eighty calendar days. Jacksonville investors selling single-family rentals, small multifamily buildings, or duplexes near the urban core frequently exchange into larger multifamily assets, industrial and flex space supporting the JAXPORT and Cecil Commerce Center corridors, or single-tenant net lease retail, all of which can extend an investor's cash flow and diversification without a current tax bill.

Not every rental property sale is a good candidate for a full exchange. An investor who wants to retire from active property management, who needs a portion of the proceeds for a purpose unrelated to real estate, or who cannot identify suitable replacement property within the forty-five day window may choose to pay tax on some or all of the gain rather than force an exchange. In these situations, an investor can also complete a partial exchange, reinvesting most of the proceeds into replacement property while paying tax only on the cash or debt reduction, known as boot, that is not reinvested. Because the calculations involve basis history, depreciation schedules, and closing cost allocations that differ from property to property, we recommend that a Jacksonville-area rental property owner review the numbers with a tax advisor and a Qualified Intermediary before listing the property, so that the forty-five day identification clock does not begin before an exchange strategy is in place.