Q. I inherited a house 11 years ago. The house was then worth $ 887,000. It’s now worth $ 1.567 million. I want to sell the house and buy a new apartment. If I sell, it looks like I have close to $ 800,000 in capital gains. I own the house directly, so there is no mortgage. How can I avoid or reduce the tax?
A. It is wonderful that you have built this type of equity in your inherited home.
Since real estate is considered a capital investment and has so greatly increased in value, you have to pay capital gains tax.
You won’t owe all profits, however, said Matthew DeFelice, a certified financial planner with US Financial Services in Fairfield.
Thanks to the Taxpayer Relief Act of 1997, you can get a huge tax break if you’ve lived in the home as your primary residence in two of the past five years, DeFelice said.
“Individual filings are exempt from capital gains tax on the first $ 250,000, and married couples filing together are exempt from the first $ 500,000 in profits,” he said. “This exemption is only allowed every two years, and as a seller, you must not have sold another home or used the exemption in the past two years.”
Plus, you can add any home improvements, renovations, or additions you’ve made to the property to your cost base, further reducing the taxes you owe, he said.
According to the current tax law, the remaining profit amount is taxed at 0%, 15% or 20% depending on income and registration status:
In 2021, if you have an income of less than $ 40,400 or are married together with an income of less than $ 80,800, the 0% rate will apply to you. The 15% range applies to singles with an income between $ 40,401 and $ 445,850 and for married couples between $ 80,801 and $ 501,600. Those with incomes above this level will be in the 20 percent group.
The IRS also charges the highest income investors an additional 3.8% net investment tax (NIIT) on top of the 20% capital gains tax, Defelice said.
Defelice said, taking your home as an example, and assuming you are married with a household income of $ 250,000 and you have made $ 100,000 in home improvements over the years since you inherited the property, it would look like this:
Sale Price: $ 1,567,000 (minus brokerage commissions and closing charges) Cost Base: ($ 887,000) Home Improvement: ($ 100,000) Exemption: ($ 500,000) Capital Gains: $ 80,000 X 15% = $ 12,000 federal capital gains tax owed
President Joe Biden’s American Families Plan is likely to include a large increase in the highest federal tax rate on long-term capital gains and qualified dividends from 23.8% today to 39.6% for high earners currently in the highest federal income tax bracket, DeFelice said.
Including net investment income tax, the top tax rate on capital gains would be 43.4%, he said.
“Rates would be even higher in many states due to state and local capital gains taxes, resulting in a combined average rate of 48% versus about 29% under applicable law,” DeFelice said. “It should be noted, however, that only wealthy individuals who earn more than $ 1 million a year would be subject to the increased tax, and those who do not would be largely unaffected.”
Of course, there is no guarantee that the proposed capital gains tax hike will ever materialize.
“The president’s plan needs to be passed by Congress before they can sign it – and it will likely have to fight to get it there. So wealthy investors shouldn’t panic just yet, but now, just in case, think about a future with higher capital gains, ”he said.
Email your questions to [email protected].
Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.