Potential sellers of residential rental properties need to be very aware that the capital gain from such a sale may surprisingly put them in a higher tax bracket and have part of their capital gain taxed at 20%.

There has been little written on the application of the 2013 Capital Gain rates. Until the IRS publishes a 2013 Schedule D Capital Gain Tax Worksheet, the following working rule will help explain the 15% and 20% capital gain rate application split:

WORKING RULE: That portion of the net capital gain (Form 1040, Line 13), that puts taxable income (Form 1040, Line 43) over $400,000 for single filers, or $450,000, for married filing jointly filers, is taxed at 20%.

However, if the seller does a 1031 exchange all the profit and depreciation is deferred and not taxed in the year of sale. Also, the seller may avoid movement of his income past a higher threshold, like that for the 3.8% Medicare Tax, and into an expensive higher marginal tax bracket for all other income.

The authority for this split capital gain tax is “Public Law 112-240, American Taxpayer Relief Act of 2012, Section 102(b)(1)(D).