This gives the adjusted basis. Subtract the adjusted basis from the sale price and that is the taxable gain. But there is more.

Any gain represented by depreciation is subject to depreciation recapture at a maximum rate of 25%. The actual rate is determined by your marginal rate for ordinary income. For example, the house sold for $250,000. Adjusted basis was $100,000 for a gain of $150,000. However, $50,000 of that gain was due to that amount of depreciation, so that’s subject to the maximum 25% rate with the remaining $100,000 taxed as capital gains.

The rate on the capital gain portion depends on the marginal tax bracket. If taxable income is in the 10-15% bracket there is a zero rate that applies. For married filing jointly, that would be for taxable income up to $75,300. If taxable income is in the 25 – 35% brackets, the rate is 15%. This would be for taxable incomes of $75,301 – 466,950. Above that, the gain would be subject to a 20% rate. If the gain from the sale of the house takes overlaps brackets, the gain would be subject partially at zero and partially at 15%

There is another fly in the ointment, thanks to The Affordable Care Act. If modified adjusted gross income is in excess of $250,000 a 3.8% Net Investment Income Tax applies. This is levied on net investment income. Investment income for this purpose includes: interest; dividends; capital gains from sale of stock, bonds, mutual funds, investment real estate; capital gain distributions from mutual funds; rental and royalty income; nonqualified annuities; and business income from passive activities. The net investment income tax applies to the lesser of net investment income or the excess of modified AGI over the threshold amount.

The sale is reported on Form 4797 and Schedule D. Your local CPA or Enrolled Agent can help you navigate these treacherous waters, especially if a Form 3115 is involved.