As we come to the end of the year, three things seem to be on everyone’s mind. Family, food and next year’s taxes. We have a month left to make strategic decisions to lessen our tax burden for the year and those in real estate transaction want to know if they are making the right decisions as they pertain to taxes.
There are a lot of myths and misunderstandings when it comes to taxes and real estate. Many of my clients assume they will pay a huge tax on their proceeds when they sell their home or that they need to buy another home in the same tax year to avoid taxes. While these assumptions are based on truth for some people, they are many factors that impact what Uncle Sam will ask you to pay.
The most important and beneficial thing you can do when it comes to buying or selling a home is to talk to your tax advisor long before you actually buy or sell and make that conversation part of your early planning. If that’s not possible, then simply call your tax professional as soon as you know you will be buying or selling.
If you are in Washington state, I recommend:
Edward Harris, EA ~ North West Tax Specialists Inc.
12011 NE First Street, Ste 205, Bellevue, WA 98005-4811
425-709-6800 Ext. 302 ~ Fax 425-709-6801 ~ www.NWTaxUSA.com ~ Email EdHarris@att.net
For those in other areas, please feel free to contact me or Ed and we can get you a great resource for your area.
So what are the 3 most common tax questions?
How much capital gains tax will I have to pay?
In many cases, zero? If you are selling your primary home (the home you lived in most of the year); the IRS currently gives you a generous exemption of up to $500,000 for married couples and up to $250,000 for an unmarried person. This exemption is on your profit, not the sales price. For example, if you sell your home for $750,000 but you paid $600,000 you have only made a gain of roughly $150,000 which is below the exemption amount for both single and married people.
Only those who have realized a gain over the applicable amount for their marital status need to worry about home improvements, costs to sell and other factors.
For example, if we assume the original purchase price was $400,000, and the homeowner was married when the home was purchased but is now single there are some additional numbers that have to be reviewed. On a sales price of $750,000; now the gain is $350,000 so the tax liability may kick into effect for the $100,000 over the exemption amount. The homeowner in this instance will want to provide receipts for all expenses related to the home (improvements, remodeling expenses and cost to sell) and go see a tax professional.
What if I put all the gains from the sale of my current home into the purchase of a new home?
Many clients of mine wrongly assume that the proceeds from the sale of their first home can be used towards the purchase of their second home and that will protect them from a capital gains tax.
This assumption stems from the opportunity investors have to utilize a 1031 exchange when selling an investment home to purchase another investment home. There are a few rules with 1031 exchanges that you should now about before selling real estate.
- You can’t touch the money. If you are participating in a 1031 exchange, you must set the exchange up prior to closing on the sale of the property with the gain. This allows the escrow or settlement firm to send the proceeds directly to the exchange program instead of to you. It is imperative you have an experienced and savvy tax professional guiding you on this process.
- You have 45 days to designate a small number of possible properties that you will purchase with these funds and you must close the transaction within 6 months of the closing date on the original property.
- These rules only apply to investment properties, not homes used for personal use.
Why do I have to pay excise tax on the sale of my home?
In Washington State, everyone pays excise tax on the sale of real property. It is a tax on the sale of real estate. The real estate excise tax is typically paid by the seller of the property, although the buyer is liable for the tax if it is not paid. The tax applies to the seller. The tax also applies to transfers of controlling interests (50% or more) in entities that own property in the state.
This tax is usually estimated at 1.78% of the total sales price of the home. What you paid for the home is irrelevant. Your marital status and your income are also irrelevant. Read more here.
What deductions can I take when I file my taxes?
If you sold or bought a home, you’ll want to take your settlement statement to your tax professional. If you cannot find your settlement statement, your real estate professional or the escrow firm that handled the closing of your transaction can provide it to you.
Take heart, Capital Gains are usually taxed at a lesser rate than income tax.
Click here to learn more about the difference between Capital Gains and Income taxes. If you study the habits of the extremely rich, they work very hard to structure their income as Capital Gains instead of Income.
If you have done well enough in your investment holdings to be worried about Capital Gains you have a problem many would envy. Next week, I’ll blog about how to minimize your Real Estate Capital Gains by making a long-term plan when it comes to buying and selling real estate. Please consider subscribing to my blog to receive notifications of important topics.