How To Avoid Capital Gains Tax On Sale Of Home

How To Avoid Capital Gains Tax On Sale Of Home – Grace Enda and Grace Enda Senior Research Assistant – Tax Policy Center @graceenda William G. Gale William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow – Economic Studies, Co-Director – Urban- Tax Policy Center @ WilliamGale2

Over the past 40 years, the distribution of income and wealth has grown increasingly unequal. In addition, there has been a growing understanding that the United States faces a long-term fiscal deficit that must be addressed, at least in part, by raising revenues. For these and other reasons, proposals to raise taxes on wealthy households have received increased attention in recent years. One approach to both reducing inequality and increasing income is to reform the taxation of capital gains. One prominent proposal would be to tax capital gains as they accrue instead of waiting until an asset is sold, an approach sometimes known as “mark-to-market.”

How To Avoid Capital Gains Tax On Sale Of Home

The federal income tax does not tax all capital gains. Rather, gains are taxed in the year an asset is sold, regardless of when the gains accrued. Unrealized, accumulated capital gains are generally not considered taxable income. For example, if you bought an asset (eg a share of stock) for $100 ten years ago, and it is worth $300 now and you sell it, your taxable capital gain would be $200 in the current year, and zero in the previous years.

What Are Capital Gains Taxes And How Could They Be Reformed?

This “taxation on realization” approach has two advantages: relative ease of valuation and likelihood of investment liquidity. To determine the capital gain, and then assess tax liability, the value of the asset is simply the sale price. After realizing the gain, the selling investor should be able to use the money received for the asset to pay the capital gains tax.

First, the tax rate on realized capital gains is lower than the tax rate on wages if the asset has been held for at least a year before selling. Realized capital gains face a top statutory marginal income tax of 20 percent plus a supplementary net investment income tax of 3.8 percent, for a combined total of 23.8 percent. Earners face a top marginal tax rate of 37 percent, plus a Medicare tax rate of 2.9 percent and a supplemental tax rate of 0.9 percent, for a combined rate of 40.8 percent.

Second, capital gains taxes on accumulated capital gains are forgiven if the asset owner dies – the so-called “Angel of Death” loophole. The basis of an asset left to an heir is “stepped up” to the current value of the asset. Here’s an example: if your uncle bought an asset for $100 and sold it the day before he died for $300, he would owe capital gains tax on the $200 gain. If, instead, he held the asset until death and bequeathed it to you, you would receive the asset with a new basis of $300, not $100. No tax on the $200 capital gain is ever paid. If you later sell the asset for $350, you would have a basis of $300 and therefore pay capital gains tax of $50.

Tax rate is in the range of 28-35 percent (Gleckman 2019). At higher rates, investors would choose to hold on to assets instead

Divorce And Capital Gains Tax

Capital gains taxation is a live issue in the Democratic primaries. Joe Biden, Cory Booker, Julián Castro and Elizabeth Warren claimed taxable capital gains at death. Castro, Warren and Booker want to tax capital gains on an accrual basis. Booker and Castro, before dropping out of the race, expressed support for retrospective taxation or related policies. Reforming the capital gains tax can address inequities and inefficiencies in the current system, and it seems likely that the focus on the issue will continue in 2020. There are three times you should be aware of the possibility of being hit with capital gains tax. When you sell your primary residence for a large profit, when you consider converting your primary residence into an investment property, and when you build your investment portfolio.

Full disclosure, we are not tax advisors. Get yourself a good one that you can ask as many questions without hesitation. We can, however, help you understand capital gains taxes in a nutshell. You’ll know some of the terminology and questions to ask when you sit down with your savvy and experienced Tax Accountant or Advisor.

Capital Gains Taxes are applied to the “gain” you make on the sale of a home. Capital gains, as they are called in the business, always apply to second homes and investment properties. Your primary residence is usually NOT involved in capital gains taxes, unless your earnings are more than $250,000 as a single owner or more than $500,000 for a married couple filing jointly.

The gain is the profit you make from selling the property. For example, if you bought your home for $320k and sell it for $400k, that would be an $80k gain. Note that there are line items such as closing costs, commissions, improvements and depreciation that can adjust that final profit calculation. That’s where your tax accountant can help you understand your real bottom line.

How To Avoid Capital Gains Tax On Appreciated Stock Positions

There are two capital gains taxes to be aware of, Federal and State. The Federal rate is based on your tax bracket and depending on your income can be either 15% or 20%. Pennsylvania has an additional 3.07% (2022).

You are looking to move to a larger home and your current primary residence would make a great rental. Before you become a landlord, sit down with your realtor and tax accountant to make sure the numbers make sense.

The government allows a grace period before the capital gains taxes kick in. As long as you have lived in the home as your primary residence for two years out of the last five, you can sell your home without paying capital gains taxes. It doesn’t need to be a sequential timeline. Once you’ve been away for 25+ months out of the last 60, your property is considered a taxable investment.

Many homeowners choose to rent out the property to make some cash flow and pay off the main portion of their mortgage during this two-year period without considering the maintenance, management and cost of repairs. The risk, if the timing is not perfect, is that capital gains tax eats up the profit.

Capital Gains Tax Deferral

For example, You bought the property for $320k. You plan to rent it for $2300 per month. After the monthly mortgage payment, not taking into account vacancy and repairs, you cash flow $300/month. Let’s pretend your tenant has 24 months left, you don’t have to fix anything or pay for rent or management, and you pocket $7,200, but during these two years you decide being a landlord is too stressful and you want out of your equity. so you decide to sell the house.

Because the two-year grace period has passed, when you sell, you will now have to pay capital gains tax on the difference between what you bought your house for and what you sell it for minus expenses. The sale price of the property is $400k so capital gains tax will be applied to the $80k gain, less about 13% closing costs on the original purchase and the sale. Let’s estimate that your earnings are $32,000, and it is taxed at 19% (Federal and state) which equals $6,080 that is owed. Unless it is offset by depreciation, that $7,200 in rental income that was taxed at income tax rates is neutralized by capital gains tax.

There must be a way to avoid capital gains taxes if so many individuals are investors and landlords. Yes, if you are an established investor, you may be able to defer capital gains taxes by taking advantage of the 1031 Exchange. Remember that a

Means that eventually when your original investment ends up in another property and another property, capital gains taxes may be due.

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If you’re new to investing and can’t shake the urge to become a landlord, familiarize yourself with the 1031 Exchange, a tool that allows you to defer the capital gains tax that would otherwise be due when you file your taxes for the year of the sale. We have a whole blog you can read about the benefits of how this tax exemption works.

If you want to dive deeper into the capital gains tax exceptions and rules, here’s a great article on Investopedia for reference. Give us a ring if you would like a Tax Advisor recommendation or if you would like to sit down with us to discuss your options.

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A Guide To Capital Gains Tax On Real Estate Sales

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