Recording A Rental Property Sale With A Journal Entry

Selling a rental property is a significant financial event that requires careful accounting to ensure accurate reporting. Whether you’re a real estate investor, property manager, or accountant, knowing how to record the sale journal entry properly is essential for maintaining precise financial statements and calculating tax liabilities.

This article will walk you through the real estate accounting entries involved in the selling of a rental property, such as recording closing costs, depreciation recapture, and the gain on the property sale journal entry.

Understanding the Journal Entry for the Sale of a Rental Property

When you sell rental property, there are several financial details to track and calculate, including:

• The selling price (cash receipts or terms financing)
• The book value of the property (original cost minus net depreciation accumulated to date)
• Selling and closing costs
• Depreciation recapture
• Gain or loss on sale

A journal entry is a formal record of the transaction that essentially removes the fixed asset account from your books. It wraps up your financial tracking of the property by calculating the accumulated depreciation, mortgage payoff, and the gain or loss on the sale. All of the above aspects must be reflected in the journal entry for sale of property with closing costs so that the property transaction can be accounted for in your books.

Step 1: Determine the Property’s Book Value

Prior to recording a sale journal entry, you need to calculate the book value of the property, which is its value in your books.

Determining the book value includes:

1. Set the original cost of acquisition. This includes the fixed asset purchase price, closing costs, and any improvements made to the property over the years.
2. Deduct the accumulated depreciation. The IRS allows real estate investors to depreciate fixed assets like rental properties over 27.5 years for residential properties.
3. Calculate with the book value formula. Book value is a company’s total assets minus its debts, showing its net worth.

Below is the book value formula:

Book Value = Cost of Original Acquisition + Capital Upgrades - Depreciation Accumulated

Let's say you purchased a rental house for $300,000, spent $20,000 on upgrades, and wrote off $50,000 depreciation. According to the above formula, the book value for this property would be:

$300,000 + $20,000 - $50,000 = $270,000

That amount is what will show in the real estate accounting entries when you dispose of the property and the loan account.

Step 2: Record the Journal Entry for the Sale of the Property

When the property is sold, a gain or loss on sale journal entry must be recorded based on the difference between the sale price and book value.

Suppose you sell the rental property at $350,000 with a closing cost of $10,000 (payment to agent and lawyer) and the book value of the property is $270,000.

The journal entry for this sale would look something like this:

• Debit to Cash: For the receipt from the buyer ($350,000 - $10,000 = $340,000).
• Debit to Accumulated Depreciation: To undo previous depreciation deducted on the property.
• Credit to Property Asset Account: To undo the cost of the original property.
• Credit to Gain on Sale Account: To cover the profit derived from the sale.

Journal Entry for Sale of Property with Closing Costs

Account	Debit	Credit
Cash (Sale Price - Costs)	$340,000
Accumulated Depreciation	$50,000
Property Asset		$320,000
Gain on Sale		$70,000

The gain on sale journal entry reflects a $70,000 gain, which is subject to capital gains tax and depreciation recapture.

Step 3: Handling Depreciation Recapture

Depreciation recapture occurs when you sell a rental property for more than its depreciated value. The IRS “recaptures” the depreciation you’ve deducted over the useful life of your property and requires landlords to report it as ordinary income.

The depreciation that was previously claimed ($50,000 in our example) is taxed at a maximum rate of 25%. The remaining profit ($20,000) is taxed as capital gain, based on your tax bracket.

Refer to IRS Form 4797 (Sales of Business Property) for more information about reporting depreciation recapture.

Step 4: Accounting for Closing Costs and Selling Expenses

Closing costs are directly deducted from the sale proceeds. Selling expenses typically include:

• Real estate commissions
• Title transfer fees
• Attorney fees
• Inspection and repair costs related to the sale

Closing costs should also be recorded in your journal entry. Since closing costs are deducted from the total sale proceeds, they are debited from the ultimate cash received.

Using our previous example:

Account	Debit	Credit
Cash	$340,000
Closing Costs (Expenses)	$10,000
Accumulated Depreciation	$50,000
Property Asset		$320,000
Gain on Sale		$70,000

This entry ensures the real estate accounting entries reflect the accurate net proceeds from the sale.

Step 5: Reporting the Sale on Tax Returns

The IRS requires landlords to report sales of rental property on Form 4797 and Schedule D (for capital gains tax calculation). The key items to report are:

1. Total sale price
2. Property's adjusted basis (book value)
3. Gain or loss on sale
4. Depreciation recapture amount

An incorrect reporting of depreciation recapture can lead to penalties by the IRS; therefore, proper recording is essential.

Common Mistakes to Avoid in Real Estate Accounting Entries

There are a few mistakes to avoid as a landlord to ensure you report your finances correctly after selling a rental property.

• Failing to Account for Depreciation Properly: Account for depreciation expenses year after year to record it accurately and avoid errors in calculating capital gains.
• Forgetting Closing Costs: Omitting closing costs when determining taxable gains makes one pay more tax.
• Merging Business and Personal Business Dealings: Separate rental property dealings from personal matters via different bank accounts to maintain clear records and an accurate balance sheet.
• Misclassifying Gains: Long-term capital gains (properties held for more than a year) are treated preferentially for tax purposes compared to short-term gains.

Avoiding such mistakes ensures that landlords offer accurate financial reporting and reduce taxes paid.

Final Thoughts on Journal Entries for the Sale of Rental Property

It is important for real estate investors to know how to properly account for a sale journal entry to keep their books clean and limit tax reporting.

Below is a list of takeaway tips:

• Calculate book value before recording the sale
• Record gains, closing costs, and depreciation recapture properly
• Keep tax compliance by reporting the sale on IRS Form 4797
• Keep proper records to prevent IRS audits

By following these steps, landlords can accurately record real estate accounting entries for sales of rental properties or other fixed assets with confidence in their financial data accuracy and tax compliance.