Loans don't affect gains on investment property sales.
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When you sell investment property, all of your profits are subject to either capital gains tax or depreciation recapture tax, which is a special type of capital gains tax. Your tax gets calculated on the difference between your cost basis and your selling price. Any debt that you owe, such as in the form of a mortgage, will not affect your capital gains liability.
Your Cost Basis
Your cost basis isn't the purchase price of your investment property. The initial cost is what you actually paid at the closing, including your closing costs. For example, if you bought a small apartment building for $1 million and paid $1,500 in title fees, $5,000 in attorney's fees, $2,000 in miscellaneous fees and $8,000 in inspection fees, your actual cost would be $1.0165. To that cost, add the cost of any
improvements you made to the property. Improvements are anything that changes your property's use, increases its value or extends its useful life. Taking the apartment building as an example, a $50,000 roof and $115,000 in kitchen and bathroom renovations would count as improvements and increase your cost basis to $1.1815 million.
Depreciation and Basis
While you own your investment property, the tax code lets you claim a small portion of its cost basis every year as a depreciation write-off. Depreciation is an accounting tool that simulates the gradual deterioration of buildings. If you sell it for more than the depreciated value, though, the IRS will want you to return a portion of the money that you saved by claiming depreciation. To properly calculate your capital gains liability, you will need to total all of the depreciation that you were legally entitled to claim, whether or not you actually claimed it.
Calculating Tax Liability