Taxes can seem complicated and overwhelming, especially when different laws come into place. When introduced to real estate investments and selling homes, this gets even more complex. Capital gains tax is one tax that many first-time investors and sellers are confused about. With little to no knowledge about the importance of this tax or even what it is, there’s bound to be skepticism and confusion involved.
Fortunately, Robert DeFalco Realty is here to delve into the topic. This article will explain what capital gains is, the importance of capital gains , and the impact of capital gains tax on real estate. Keep on reading to understand this important topic.
What Is Capital Gains Tax?
Capital gains tax refers to the tax applied to the profit you make when you sell an investment. This applies to all kinds of investments, including stock shares, jewelry, bonds, and real estate. In this article, we’re discussing the capital gains tax on property.
It’s important to note that this tax isn’t applied to your assets until sold. As long as you’re the owner, you have “unrealized capital gains.” It’s only once you sell your assets and make a profit that you must pay the tax.
Long-Term Capital Gains
In the U.S., capital gains tax only applies to assets you have owned for more than a year before selling them. This is “long-term capital gains.” However, how much you pay in capital gains depends on your tax bracket and can go up to 20%.
Short-Term Capital Gains
While individuals also have to pay tax on assets they sell before owning them for more than a year, it isn’t capital gains tax. In fact, it’s referred to as “short-term capital gains.” Instead, the profit from the sale of these assets counts as regular income. That is how individuals pay taxes on it.
Unfortunately, short-term capital gains have a higher tax rate than long-term capital gains, making this a con for everyone except extremely wealthy individuals. It also gives people an incentive to hold on to their assets for a longer period of time.
What Is the Importance of Capital Gains in Real Estate?
Since capital gains tax applies to all capital assets you sell, it’s also applicable for real estate. If you’re selling investment properties or your home, you need to know the rules surrounding this. You have to be aware of the terms of capital gains when selling a house. Being aware of the rules and regulations can help you avoid paying unnecessarily high taxes. It also ensures you follow the law and avoid trouble down the road.
Capital Gains When Selling a House (Residence)
Capital gains tax on real estate differs depending on the type of real estate you’re selling. For example, selling your home (primary residence) is very different from selling an investment property. Therefore, if you’re selling your residence and you’ve lived there for at least two years, a different standard applies to you.
You can exclude $250,000 of the capital gains from selling a home from being taxed. If you’re married and are filing jointly, this goes up to $500,000. For example, if you bought your house for $300,000 and sold it for $600,000, your profit is $300,000. If this is your primary residence, you can exclude $250,000 from taxable income. Therefore, you only have to pay capital gains tax on the remaining $50,000.
However, unlike with investment properties, you can’t file capital losses. These aren’t deductible from gains. In some cases, you can deduct the cost of improvements and repairs to the home from capital gains. Discuss this with your realtor for more information.
Capital Gains When Selling an Investment Property
Capital gains tax on property is very different for investments. Since the property’s condition deteriorates, investors use a concept called “depreciation deductions.” Unlike the traditional use of the word “depreciation,” this doesn’t refer to the home’s value. It refers to its physical condition as the property gets older.
However, it’s important to note that depreciation deductions don’t reduce capital gains. They reduce the price you originally paid. If you paid $500,000 and reported a depreciation deduction of $100,000, the original price will go down to $400,000. This can increase the taxable capital gain since your profit is higher. The recaptured amount has a 25% tax, and your tax would depend on your income as usual.
However, if you’re wealthy and have an extremely high income, you may also have to pay a net investment income tax. If your modified adjusted gross income (MAGI) is more than a specific amount, you will have to pay this tax. It will apply to your investment income, which includes capital gains.
Lowering the Tax on Real Estate
There are many strategies you can use to maximize your returns and end up paying less in capital gains tax. These are all legitimate ways that can maximize your investment. These can range from holding the property for a longer time to invoking the 1031 exchange and deferring capital gains.
If you’re interested in reducing capital gains when selling a property, you’ll need an experienced real estate agent and lawyer. Both will help you develop the best strategy to minimize your payment.
The Seller’s Agents at Robert DeFalco Realty Can Help
We understand that capital gains can be a confusing topic. It can get especially complicated when it comes to capital gains tax on real estate. That’s why you need an experienced real estate agent and real estate lawyer in your corner. At Robert DeFalco Realty, we can help you sell your real estate investment properties and your homes. We can also put you in touch with experienced real estate lawyers and accountants, so the entire selling process goes smoothly.