What are Capital Gains Taxes?
One of the biggest reasons people buy real estate is the potential appreciation and ability to build wealth over time. But what happens when you sell? Just about every time you make money, you have to pay taxes. Whether it is income tax, capital gains, or some other form of taxation. This is no different when you sell real estate, but there are exceptions. Property falls under assets and are subject to capital gains taxes depending on the use and length of ownership.
Property that doesn’t qualify as a Primary Residence
If you were to sell an investment property for a profit, there will be capital gains taxes due. If you’ve owned the property for less then one year (ie. if you flip a home), that gain would be taxed as short term capital gains. Every situation is different, but short term capital gains are typically taxed as ordinary income. If you sell a property you’ve owned for over one year, it will be taxed as long term capital gains. Capital gains tax varies from 0%, 15%, and 20% based on income tax brackets. Click here to see an easy breakdown depending on how you file, as well as a 2020 capital gains tax calculator.
|Example||Sales Price||Original Purchase Price||Est. Selling Costs||Improvements||Profits|
I’ve included a table above with three hypothetical scenarios to make it easier to follow. When calculating capital gains, the cost of selling and improvements made to the property bring down the tax basis. The easiest way of calculating this is deducting the costs of selling and improvements from the profits to bring down the amount that would be subject to capital gains tax. In these three scenarios, the profits would be subject to capital gains if this property does not qualify as a primary residence.
Selling your Primary Residence
When you sell your primary residence, it is a bit different. If you’ve lived in your home for a minimum of two out of the last five years, you likely qualify for Capital Gains Protection. For a seller that files taxes as an individual, they qualify for up to $250,000 in capital gains protection. For sellers that are married and file jointly, they qualify for up to $500,000 in capital gains protection. This is one of the largest tax savings available.
If we apply the same scenarios in the table above, we can see the significance of the capital gains protection. In Example No. 1, the seller(s) would be exempt from capital gains on the $227,000 profit if the property qualifies as a primary residence. In Example No. 2, a married couple would have capital gains protection on the full amount, while an individual would need to pay long term capital gains on $152,000 of the profits versus the entire $402,000. Example No. 3 is similar as No2. The married couple would be covered by the capital gains protection, but the individual would have about $133,000 in profits that would be subject to long term capital gains. All three of these scenarios potentially save the sellers (both married and single) tens of thousands of dollars in taxes.
There are many different scenarios, so we would be more than happy to discuss your personal situation.