Part 1 - Capital Gains Taxes apply to your Personal Residence
7 Dec 2008
First some definitions and facts:
Capital Gain is the profit realized from the sale of any capital investment including real estate.
Short Term Capital Gains are:
- Assets held for less than one year
- Taxed at the marginal rate of the taxpayers income
Long Term Capital Gains are:
- Assets held for 12 months and sold after May 5, 2003
- Taxed at a 15% rate, if the taxpayers marginal tax rate above the 15% income bracket
- However, the gain is taxed at 5% when the taxpayer is in the 15% income bracket or below.
This includes:
- Principal Residence
- Commercial Properties
- Investment Properties
Capital Losses
- Capital losses occur when an investment or other types of property are sold at a loss.
- Capital gains can be reduced by capital losses.
- Net capital losses may be deducted from taxable income up to $3,000 per year and the unused loss carried over.
With Commercial and Investment properties there are two Capital Gains Taxes. The first applies to the net gain or profit from the sale and is considered a tax on “appreciation” of value. The second is a tax on “depreciation recapture” (which will be covered in next month’s article).
Sale of your Primary/Principal Residence
The profit made from selling your personal residence is subject to a Capital Gains Tax based upon your taxable income level. For most homeowners this is a tax of 15% of your gain in value. However, the IRS provides a “Residential Exclusion”:
- Homeowners may exclude the first $250,000 in gain ($500,000 if married and filing jointly) on the sale of one home every two years.
- To be eligible home seller must have owned and resided in the home for two of the last five years before the sale.
Terms:
Basis – usually the cost of a property.
Adjusted Basis – is the original cost or basis plus certain additions and minus certain deductions. An increase in Basis will reduce the taxable gain.
Buyers may add these costs to the Basis:
- Title Abstracts
- Title Insurance
- Attorneys Fees
Sellers may add these costs to the basis:
- Transfer Taxes
- Attorneys Fees
- Real Estate Commissions
- Residential - repairs made to the house within 90 days of the sale.
Sale of Personal Residential - Example of Capital Gains Tax
Purchase price (20 yrs ago) $125,000
Improvements (added a room) + 30,000
Adjusted Basis $155,000
Sale Price $885,000
Less Adjusted Basis -155,000
Less Cost of Sale -56,640
Net Profits $673,360
Capital Gain Exclusion -500,000*
Capital Gain $173,360
Capital Gains Tax (15%) $26,004
* Married, filing jointly. If this were a single or divorced owner the exclusion would be $250,000; the gain $423,360; the Capital Gains Tax $63,504!
In many areas the property values are lower and the Residential Exclusion is sufficient to avoid a taxable gain. But, as real estate agents we should advise our clients of the possibility of their being subject to a Capital Gains Tax and to discuss this with their accountant or tax advisor.
Next month in Part 2 we will examine thi impact of Capital Gains Taxes on Investment Property.
Edward S. Smith, Jr., CREI, CIC, ITI, RECS
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