Capital Gains on Rental Property

An investor who sells a rental property in Baltimore, MD generally owes federal capital gains tax on the difference between the net sale price and the adjusted cost basis of the property. Adjusted basis is not simply the original purchase price. It is the purchase price plus the cost of capital improvements, minus accumulated depreciation claimed over the years the property was held as a rental. Because depreciation lowers the basis year after year, a long held rental property often carries a much larger taxable gain than an investor expects, even if the property did not appreciate dramatically in market value. The federal long term capital gains rate applies if the property was held for more than one year, and a separate depreciation recapture portion of the gain is generally taxed at a different rate, up to twenty five percent, because it represents value the investor already deducted against ordinary income in prior years. On top of the federal calculation, Maryland imposes its own graduated state income tax on the gain, and the county or municipality where the seller resides layers a county piggyback local income tax on top of the state rate. For a seller who is not a Maryland resident, Maryland also requires withholding on the sale proceeds at closing, calculated as a percentage of the total consideration or the recognized gain, which the settlement agent remits to the state. Section 1031 of the Internal Revenue Code offers a path to defer, not eliminate, this combined federal, state, and local tax exposure when the rental property is exchanged for another qualifying like kind investment property rather than sold outright for cash. To qualify, the relinquished property and the replacement property must both be held for investment or business use, the investor must identify replacement property in writing within the forty five day identification period, and the exchange must close within the one hundred eighty day exchange period, all coordinated through a Qualified Intermediary who holds the sale proceeds so the investor never has direct access to the cash. We help investors in Baltimore, MD who are evaluating a sale of rental property first understand the size of the capital gains and depreciation recapture exposure they are facing under current federal, Maryland, and county piggyback rules, and then walk through whether a like kind exchange into replacement property, including passive options such as a Delaware Statutory Trust, fits their goals. This includes reviewing the rental property's basis history, estimating the combined tax exposure of an outright sale, and comparing that exposure against the identification and closing timelines required to defer it through an exchange. Because every basis calculation depends on the specific improvements, depreciation schedule, and holding period of the property, we coordinate closely with the investor's tax preparer and the Qualified Intermediary rather than performing the tax calculation ourselves.