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Photo: Alexsl / Getty Images
Photo: Alexsl / Getty Images
Photo: Alexsl / Getty Images
How much does capital tax on real estate cost? Plus: how to avoid it
Capital gains tax is the income tax you pay on profits from the sale of capital assets, including real estate. So if you’ve sold or are selling a home, what does that mean to you?
If you’re selling your home for more than you paid for it, that’s good news. The downside, however, is that you are likely to have a capital gain. And you may have to pay tax on your capital gains in the form of capital gains tax.
Just as you pay income tax and sales tax, profits from your home sale are subject to taxation.
To make matters worse, the law on tax cuts and employment, which came into force in 2018, changed the rules somewhat. Here’s what you need to know about all things capital gains.
What is capital gains tax – and who pays it?
In short, capital gains tax is a tax levied on possessions and property – including your home – that you sell for a profit.
If you sell it in a year or less, you will have a short-term capital gain.
If you sell the home after holding it for more than a year, you will have long term capital gain. Unlike short-term gains, long-term gains are subject to preferential capital gains tax rates.
What about the main residence tax exemption?
Unlike other investments, home sales profits benefit from capital gain exemptions that you might qualify for under certain conditions, he says Kyle White, an agent at Re / Max Advantage Plus in Minneapolis – St. Paul.
The IRS grants everyone, regardless of how much they earn, a tax-free tax exemption of $ 250,000 on capital gains from a primary residence. You can permanently exclude this capital gain from your income.
“If you and your spouse buy your home for $ 100,000 and sell it years later for up to $ 600,000, you don’t have to pay capital gains tax,” says the New York attorney Anthony S. Park. However, you must meet certain requirements to apply for this capital gain exemption:
- The house must be your main residence.
- You must have owned it for at least two years.
- You must have lived in it for at least two of the last five years.
- You cannot have made this exclusion in the past two years.
If you don’t meet all of these requirements, you may be able to get a partial exemption for capital gains tax if you meet certain exemptions (e.g. if your job forces you to move before you live at home for two years). Contact a tax advisor or IRS Publication 523 for more information.
What is my investment income tax rate?
How much tax will Uncle Sam take on capital gains beyond this $ 250,000 per person exemption from your long-term property sale? Under the new tax law, long-term investment income tax rates are based on your income (prior to 2018, they were based on tax brackets), explains Park.
Let’s sum it up.
For individuals, you can take advantage of the 0% Capital Earnings Rate if your 2020 income is less than $ 40,000. Most individuals fall into the 15% capital gain rate that applies to incomes between $ 40,001 and $ 441,500. Individual applicants with incomes in excess of $ 441,500 will be affected by a 20% long-term capital recovery rate.
The brackets are a bit larger for married couples filing together, but most will be affected by the marriage tax penalty here. Married couples with an income of $ 80,000 or less stay in the 0% class, which is good news. However, married couples earning between $ 80,001 and $ 496,600 have a capital return rate of 15%. Those with incomes greater than $ 496,600 will be affected by a long-term capital return rate of 20%.
- Your tax rate is 0% on long-term capital gains, though You are a single applicant making less than $ 40,000, a married applicant who collectively makes less than $ 80,000, or a householder who makes less than $ 53,600.
- Your tax rate is 15% on long-term capital gains, though You’re a single applicant who makes between $ 40,000 and $ 441,500, a married applicant who collectively makes between $ 80,001 and $ 486,600, or a head of household who makes between $ 53,601 and $ 469,050.
- Your tax rate is 20% on long-term capital gains, though You are a single registrant, married, married, or a householder who makes more than $ 496,600. For those who earn more than $ 496,600, the rate is 20%, according to Park.
Don’t forget that your state may have its own tax on capital gains income. And very high income taxpayers may pay a higher effective tax rate due to an additional 3.8% net investment tax.
If you’ve held the property for a year or less, this is a short-term gain. You pay normal income tax rates on your short-term capital gains. These are the same rates of income tax that you would pay on any other normal income such as wages.
Will Home Improvement Reduce Capital Gains Tax?
You can also choose to reduce the amount of capital gains tax that is subject to capital gains tax to help reduce the cost of renovations you undertake. You can add the amount you’ve spent on renovations – like replacing the roof, building a deck, replacing the floor, or finishing a basement – to the starting price of your home to get the adjusted cost base. The higher your adjusted cost base, the lower your capital gain on selling the home.
For example, if you bought your home for $ 200,000 in 1990 and sold it for $ 550,000, but spent $ 100,000 on home improvement over the past three decades. That $ 100,000 would be deducted from the selling price of your home this year. Instead of owing capital gains taxes on the profit of $ 350,000 on the sale, you would owe tax on $ 250,000. If so, you would qualify for an investment income tax exemption and owe nothing.
Take away lesson: Make sure to keep the receipts for renovation work as they can help lower your taxable income when selling your home. Note, however, that these must be home improvement. You cannot deduct income for normal repairs and maintenance on your home.
How the Capital Gain Tax Works for Inherited Homes
What if you sell a home that you inherited from deceased family members? The IRS also offers a “Free Base Top Up” when you inherit a family home. But what does that mean?
Let’s say mom and dad bought the family home for $ 100,000 years ago, and it’s worth $ 1 million if it’s up to you. When you sell, your purchase price (or “base”) is not the $ 100,000 your people paid, but the $ 1 million it is worth on the last parent’s death date.
You only pay capital gains tax on the difference between what you sell the house for and what it was worth when your last parent died.
What if I have a loss from selling real estate?
If you sell your personal residence for less than you paid for it, you cannot deduct the capital loss. It is considered a personal loss and a loss of capital from the sale of your home will not reduce your taxable income.
However, if you sell other properties at a loss, you can claim a tax loss on your income tax return. There may be a limit to the amount of loss that you can use to offset other taxable income in a year.
As a real estate investor, you can avoid capital gains taxes
If the home you’re selling isn’t your primary residence, but is an investment property you’ve turned over or rented out, avoiding capital gains taxes is a little more complicated. But it is still possible. The best way to avoid capital gains tax if you are an investor is to swap “like” properties for a 1031 exchange. That way, you can sell your property and buy another without realizing any potential profit in the tax year of the sale.
“Essentially, you’re exchanging one asset for another,” says White of Re / Max Advantage Plus. However, he warns that there are very strict rules for schedules and guidelines in this transaction. You should therefore check these with an accountant.
If you deregister from the rental property investment business and put your money in another company that doesn’t qualify for the 1031 exchange, you owe capital gains tax on profits.
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