If you’re like most homeowners, you might not be aware that the federal capital gains tax could apply to the sale of your home. Unlike regular income tax, capital gains tax is applied to the income that you earn as a result of the sale of a tangible asset like a stock or real estate property. In rare cases, it may be applied to non-liquid assets like art pieces and wine collections.
If you turn a profit on the sale of any residential or commercial property that you own, you must be prepared to pay capital gains tax on it. By contrast, you must be prepared to write off any loss that you take on the sale of such a property. To write off a loss, you’ll need to subtract its value from your total taxable income.
However, there may be exceptions to this rule. In certain situations, you may be able to sell a home without paying capital gains tax on the profits. Depending upon the applicable capital gains rate for your income bracket, this could increase the value of the sale’s proceeds by as much as 40 percent.
In order to take advantage of this tax loophole, you’ll need to reinvest the proceeds from your home’s sale into the purchase of another “qualifying” property. This reinvestment must be made quickly: If you wait longer than 45 days before purchasing a new property, you won’t qualify for the tax break. For this reason, you’ll need to be ready to close on the new property immediately after selling your old house. Fortunately, many real estate brokers understand that their clients operate under this constraint. If you explain the situation to your broker, he or she is likely to delay your current home’s closing date.
To make matters even more complicated, you’ll need to involve a third party in the tax-free transaction. This individual or bank is known as the deal’s “accommodator.” Unfortunately, this person or entity must have no financial interest in the transaction. As such, your real estate broker or mortgage lender may be ineligible to fill the role.
In certain circumstances, you may be able to extend the 45-day deadline for several months. If your accommodator agrees to “identify” the property that you wish to purchase, you’ll be permitted to wait for as long as six months to close on it. During this time, you won’t have to pay interest charges or taxes on the proceeds from your old home’s sale.
Do I Have to Pay Capital Gains Tax on My Primary Residence When I Sell?
Although you may not realize it, your home is one of the largest investments that you’ll ever own. Whether it’s worth $100,000 or $500,000, its value exceeds that of all but the most expensive cars. Even if you have an investment portfolio with a value larger than that of your home, it’s probably comprised of dozens of individual tranches of stocks and bonds rather than one or two monolithic holdings.
As an investment vehicle, your home is subject to the same taxes as your other investments. The proceeds that you’ll realize from selling your home are technically “capital gains.” Although the tax code changes frequently, you should assume that any capital gains that you earn upon finalizing the sale of your home are taxable according to a simple scale.
“Long-term” capital gains are defined as gains realized on an investment held for more than one year. These are currently taxed at a 15 percent marginal rate. “Short-term” capital gains are defined as gains realized after a holding period of less than one year. These are currently taxed at the same rate as regular forms of income. In the coming years, it’s likely that tax rates on long-term capital gains will increase markedly.
However, you might not be subject to any capital gains taxes on the sale of your home. According to the Taxpayer Relief Act of 1997, you’re exempt from paying taxes on real estate capital gains of $250,000 or less. If you file your taxes jointly with your spouse, you may be exempt from paying taxes on up to $500,000 of such capital gains income.
It’s important to note that the laws governing taxes on home sales change regularly. In fact, a new law that became effective at the outset of the 2013 tax year may subject certain home-sellers to a Medicare surcharge meant to offset the cost of the Affordable Care Act. If you sold your home after January 1, 2013 and earned more than $250,000 on the sale, you’ll probably be subject to a surcharge of 3.8 percent on any capital gains that you earned in excess of the standard $250,000 exemption. You’ll need to check with your tax professional to determine how best to pay this surcharge. If you earned less than $50,000 in other income during the tax year in which you sold your home, you may not need to pay the full amount of this new Medicare tax.
Do I Need to Pay Capital Gains Tax on Investment Property?
If you’re looking to invest in real estate, the market may support your ambitions. After years of free-falling home and land prices, the American housing market appears to be bottoming. As ambitious investors continue to mop up the nation’s foreclosure overhang, the number of distressed properties appears to be shrinking at a slow but steady clip. A reduced foreclosure glut will eventually provide strong price support and may contribute to a resurgence in the value of residential property. Although the commercial property market still looks weak, it may soon follow the harder-hit residential market into recovery.
Investing in land or physical homes may be a great way to take advantage of this accelerating secular trend. Then again, real estate investments aren’t risk-free. Before you dive into the treacherous waters of real estate investing, you’ll want to understand the tax implications of your endeavor. Unlike your primary and second residences, your surplus investment properties may be subject to certain federal and state tax levies.
Chief among these additional levies will be capital gains taxes. When you sell your primary residence, you’re not required to pay capital gains taxes on the profit that you realize on the property. This long-standing rule is designed to encourage home ownership and facilitate the selling process. The gains that you realize on the sale of your “second” or vacation home are typically exempt from capital gains taxes as well.
Under the current tax laws, any additional homes that you own are treated as investments. Even if you live in your third or fourth home for several months out of the year, it will still be subject to the laws that govern investments in stocks, bonds, commodities and other traditional vehicles. As such, you’ll need to pay capital gains taxes on its sale.
If you sell your property for a loss, you may be able to deduct a certain amount of the loss from your top-line income figure. This deduction is typically capped at $3,000 per year. If your loss is larger than this amount, you may be able to “carry over” the deduction into future tax years. For instance, you might be able to claim a $9,000 capital loss on three consecutive tax returns.
Finally, it’s important to note that you can deduct the value of any improvements that you make to the home from your profit figure. Depending upon the cost of these improvements, this could substantially reduce the amount of capital gains tax that you must pay on the sale of your investment property.