Capital Gains on Investment Property

Investment property generally includes real estate held for rental income, business use, or long-term appreciation rather than as your personal residence. This covers rental houses, apartment buildings, retail and office buildings, industrial space, raw land held for investment, and similar assets. The key test the Internal Revenue Service applies is your intent and actual use of the property, not the label on the deed, which is why documentation of rental history and business use matters if your exchange is ever examined.

Start with your original purchase price plus acquisition costs such as title insurance and recording fees. Add the cost of capital improvements that extended the property's useful life or added value, such as a new roof or major renovation. Subtract depreciation you claimed or were entitled to claim over your holding period, including any accelerated depreciation from a cost segregation study. The result is your adjusted basis, and your gain is the sale price minus selling costs minus this adjusted basis.

Yes. Raw or unimproved land held for investment purposes qualifies as like-kind to virtually any other type of investment real estate, including improved commercial buildings, because the Internal Revenue Code treats all real property as like-kind to other real property when both are held for investment or business use. Land held primarily for personal use or as inventory for resale by a dealer does not qualify.

A cost segregation study reclassifies portions of a building into shorter depreciation categories, which accelerates deductions during ownership but also increases the depreciation recapture due at sale. That recapture is taxed as unrecaptured Section 1250 gain up to a 25 percent federal rate, separate from your capital gains rate. A 1031 exchange defers this recapture along with the capital gain, which is one reason cost segregation and 1031 planning are often coordinated together.

To defer the entire gain, you generally need to acquire replacement property of equal or greater value than the relinquished property and reinvest all of your net equity, while also maintaining equal or greater debt or replacing it with cash. Taking cash out or reducing your debt load without offsetting cash creates boot, which is taxable to the extent of the boot received, even though the rest of the exchange remains deferred.