Like every other sale of business property, commercial assets, financial instruments and other real property, any profits you make from the sale of rental property -- in other words, commercial or residential real estate which you own and either rent or lease to others -- is subject to capital gains tax.
The good news is that congress and the Internal Revenue Service have, in their infinite wisdom and unbounded love for landlords, have made the application of capital gains tax on rental property far less onerous that it is regarding the sale of most other assets.
The basic fact is that Congress and the IRS has made it incredibly easy to reduce -- or eliminate altogether -- the apparent profit gained from selling rental property. In fact, rental property is about the only capital gains item in the entire tax code where you can deduct everything INCLUDING the kitchen sink as profit-reducing expense. In fact, if you own a 40-unit apartment building you can deduct all 40 kitchen sinks.
Sellers of rental property can also defer paying any capital gains tax almost infinitely -- or at least long enough for that other inevitability, death, to relieve them of all their tax issues -- by taking advantage of something called the IRS Code Section 1031 tax exchange for like property provision.
In simple terms, this provision -- or to be honest and call a spade a spade, loophole big enough to drive the Space Shuttle through -- allows owners of rental properties to sell their about-to-be-condemned ghetto tenements, use the money from the sale to anything from more slumlord shacks to super-valuable undeveloped land at the end of a freeway exit to an industrial park and defer paying any capital gains tax until he sells the "like property" 20, 30 or 40 years down the road.
As we said, that's the simple explanation. Actually working the Section 1031 loophole is fairly tricky since there are such things as absolute deadlines to do this and that and certain restrictions on what you can and cannot exchange, etc. To put it bluntly, if you're planning to beat the taxman by using Section 1031 you'd be well advised having a professional IRS-agent killer (aka tax attorney or CPA) structure the deal for you.