The Four Taxes That Stack on One Closing

When a seller tells me he expects to pay capital gains tax on his sale, I know two things. He is right, and he is not finished.

Capital gains tax is one of four charges that can land on the same closing. They are assessed under different authorities, calculated on different bases, and levied at different rates. A seller who plans around one of them and not the other three will be surprised in April, and the surprise is always in the same direction.

Here is the full set.

1. Federal capital gains tax

The rate depends on how long the asset was held and on total income for the year. Held more than a year, most sellers at transaction sizes we work with land at 20 percent. Below certain thresholds the rate is 15 percent, and below that, zero.

This is the tax everyone has heard of and it is usually the largest single line. It is also, importantly, the only one of the four that many sellers have actually planned around.

2. Depreciation recapture

If the asset was depreciated, part of the gain is not treated as capital gain at all.

For real property, the depreciation you claimed as straight-line comes back as unrecaptured Section 1250 gain, taxed at a federal rate of up to 25 percent. For personal property and for certain accelerated components, Section 1245 applies and the recapture is taxed at ordinary income rates, which are higher still.

This is the line that catches people. Depreciation felt like a benefit every year of the hold. At sale, a portion of it is repaid, and at a rate above the capital gains rate. I have sat with owners who were genuinely angry to learn this, and I understand why. Nobody explained the trade at the front end.

I want to be careful here, because this cuts both ways. Accelerated depreciation is a legitimate and valuable planning tool. It simply favors long holds, because the recapture on the accelerated portion comes back at ordinary rates. If a sale is likely within a few years, that changes the math.

3. Net investment income tax

An additional 3.8 percent under Section 1411, applied to net investment income above a modified adjusted gross income threshold. For a married couple filing jointly, that threshold is $250,000.

At a large transaction, essentially the entire gain sits above the threshold. So this operates as a flat 3.8 percent surcharge on top of everything in categories one and two. It is small as a percentage and substantial as a number. On a $3,600,000 gain it is $136,800.

4. State income tax

This one varies more than the other three combined.

Several states impose no income tax at all. Others treat capital gain as ordinary income at rates in the low double digits. Some allow a partial exclusion. A few impose additional surcharges above stated income levels.

The residency question also matters and it is not always simple. Where the property sits, where the seller lives, and where the seller lived during the hold can all affect the answer. I have watched two owners of adjacent buildings, selling the same week, arrive at materially different state outcomes.

What stacking means in practice

Four charges, applied to overlapping but not identical bases.

Recapture is calculated on the depreciation taken. Capital gain is calculated on the balance. The net investment income tax applies across the whole gain. State tax applies on its own terms, sometimes on a different figure entirely.

You cannot estimate the total by picking one rate and multiplying. I have never once seen that shortcut produce a number within reach of the real one, and it is always low.

The order of operations

If you are approaching a sale, the sequence is straightforward.

• Establish adjusted basis. Original cost, plus capital improvements, less depreciation claimed.
• Separate the depreciation component from the balance of the gain, and identify which recapture rule applies to each part.
• Apply the capital gains rate to the balance.
• Add 3.8 percent across the gain if your income clears the threshold.
• Add the state.

That is a projection, not a plan. But it is the number every planning decision is measured against, and until it exists there is nothing to decide.

We call it the conventional outcome, and every analysis we produce sets it out first, before anything else. A seller should be able to see clearly what happens if he does nothing. Only then does a comparison mean anything.

This information is general and is not tax, legal, or investment advice. Rates and thresholds are stated as of publication and are subject to change. Every situation is different. Work with your own CPA and attorney before acting on any strategy.