With the new tax law coming out, many people have questions about their immediate and long-term tax consequences. One of the most timely concerns for everyone is whether the rules of capital gains, depreciation recapture, and 1031 exchange have changed since last year. We're here to help you through this process!

We've put together an overview of these important topics so that you can understand them better. First things first: what are some of these important terms? You'll find those definitions at the bottom of this post.

When you sell and buy a property, you'll have to report capital gains and losses on your income tax return each year. Capital gains are taxable income measured by the sale price of an asset. The main difference between capital gains and long-term capital losses is one day's time frame: with long-term capital losses, it takes one year for them to expire. In contrast, with short-term capital losses they're available for use as soon as the previous tax year ends (generally within 60 days). Say you bought a property last year for $1,000 and you sell it this year for $10,000. That's a $9,000 gain.

Depreciation recapture is an allowance you can take as wear and tear take place on your property. When the cost of buying or constructing a property exceeds the sale price, depreciation lets you spread the purchase price over a period of years, reducing your taxable income. If the sale price is higher than the adjusted basis, there will be tax liability to pay on that difference as depreciation recapture taxes. The rate of depreciation depends on how long it takes this difference between revenue and total cost to be paid off. Factors including functional or economic obsolescence may have a significant impact on the actual value, and this difference in revenue versus cost is measured every year to determine the amount of depreciation that can be taken.

You must pay tax on gains even if you don't have enough money to cover your expenses. For example, if you make a capital gain that brings in $5,000 but only have expenses of $4,000, you'll be left with a tax liability of $1,000. You can use any capital losses from other years to help offset this expense, reducing your balance and saving you money. However, it's important to note that net capital losses from one year can't exceed capital gains for that year.

You may be familiar with the 1031 exchange, but just in case you're not, here's a quick refresher! The 1031 exchange provision allows an investor to sell an asset and immediately buy another without paying capital gains or depreciation recapture taxes. A 1031 exchange is often used when someone has an expensive property that he or she wants to replace with a more valuable one. If you put the proceeds of your previous property toward buying a new one, there are no capital gains taxes because the money is regarded as a down payment on the replacement.

Now that you're familiar with these terms, let's examine them further.

When do I have to pay tax on my capital gains and depreciation?

The capital gain tax calculation is based on the difference between the sale price of your property and your adjusted basis in it. Your adjusted basis is the initial cost of the property, which is measured from all sources of depreciation or other adjustments. These include casualty losses, improvements to a property like a pool, the cost of taxes owed, and other adjustments to improve your asset's net worth. The proceeds from selling an asset will be reported as a capital gain or loss depending on whether they exceed or fall below its adjusted basis at the time of sale.

In short, if the sale price of your property is more than your adjusted basis, then a tax liability will be imposed on that difference. The following is how to determine the capital gain or loss at the time of sale.

Example 1: Let's assume that you bought a property for $100,000, which had a total cost of $100,000 and a $20k adjusted basis. You sell it for $120,000 (a gain of $20k). As we just learned, you have to subtract your adjusted basis from the sale price in order to determine the amount of gain. This amount is considered the capital gain on this property and must be reported as income on Schedule D.

In the example above, the $20k gain is reduced by the original adjusted basis ($20k) and we have a final capital gain of $0.

Example 2: Now let's evaluate a different property that has the following data: purchased for $100,000 with an adjusted basis of $15k, selling for $110,000. In this case, the sale price is greater than our adjusted basis so there will be a capital gain that must be reported.

When you sell your asset in a 1031 exchange, you have to pay tax on any depreciation recapture (also known as a tax-deferred exchange), if any. However, unlike a stock exchange when you sell an asset, you will not trace these gains when you sell a house.

The tax is calculated according to the following formula.

Tax = (Property selling price-adjusted basis)/2

In this case: Tax = ($120,000 – $15,000)/2 = $17,500/2 = $7,250. Your 1031 exchange is now completed with no tax liability.

The calculation for capital gain tax: Property selling price-adjusted basis

In our example: Property selling price = $120,000 – $15,000 = $105,000/2 = 61,250. The tax on this capital gain is $61,250/2=$32,625. Our 1031 exchange is completed with no tax liability.

In the example above: Property selling price = $115,000 – $40,000 = $75,000/2 = 31,500. The tax on this capital gain is $31,500/2=$12,750. Note that there's a discrepancy between the two calculations. The difference between these two amounts is that we're using the actual sale price ($115,000) in the first calculation.

Example 3: Now let's calculate a loss on a property. Say you bought a property for $100,000 and it had an adjusted basis of $75k. At the sale price of $95,000, it still had some depreciation to take off (in this case – $5k). You can save money by selling it for $95k but this time we've got to subtract the amount of depreciation which will be taxable income.

In the example above, property selling price = $95,000 – $75,000 = $5,000/2 = 1,250. The loss on this property is 1,250. The tax on this capital gain is 1,250. Since there's a shortage of money in our budget and we can't afford to pay the gain of $5k we have to reduce it by the depreciation ($5k). We have to use a subtraction: $1,250 – 5k = $1,000. We've saved $1,000 and that's what we have left in our budget.

It's important to note that the gains and losses on assets purchased before you bought your replacement property are not reflected in your sale price if you choose to sell an old asset for cash. If you purchased a house in 2007 for $200,000 but now want to sell it for $200k to buy a new one, there will be no tax implication because the gain is more than the original cost of the home ($200k-175k). The gain is a $25k increase from the original cost, but this increase isn't taxable.

However, there's a change of tune if you choose to sell your old asset for another property. If you trade in your old home for a new home of equal or greater value, there is no gain or loss. Your $15k in depreciation can be deducted from your loss (or applied to your gain) to reduce or eliminate any tax liability. If your new home costs $200k and you want to keep the same amount of capital gain, you'll only need to pay taxes on the difference between the two properties and not on the profits gained from selling one home while buying another.

Example: Let's say that you bought a property in early 2007 for $100,000 and sold it in early 2012. You originally deducted $15k in depreciation from the sale price of your old house and had a gain of $25k. If you trade this home to buy another home with an adjusted basis of $150k, there will be no tax implications. The difference between the two homes is a 20% increase, but that's not considered taxable income, because these assets have been owned by different units of analysis. If your new home costs $200k, there will be no tax implications on the difference between the two properties because they don't belong to the same unit of analysis or ownership period.

For more information, you can visit Real Estate Calculators.