Capital Gain - What You Don't Know May Hurt You
Quite often Capital Gains tax is due on sale and transfer of a real property. In 1997 tax laws were substantially modified to provide a number of measures to allow individuals to keep more of the profits earned when a sale occurs.
CAPITAL GAIN DEFINED
Gain is defined by taking the net closing proceeds and subtracting the "basis" of the property consisting of the actual price altogether with closing cost and captital improvements which enhance or extended the life of the property.
NEW RATES
Effective January 1, 2023 provided property is held 12 months or longer the basic rate for Capital Gain is 15% investors and second home owners earning less than $492,300.00 individually or $553,850.00 for couples. The rate for anyone above this income is 20%.
HEALTH CARE REFORM SUPPLEMENT TAX
The Health Care Reform Tax provides for an additional supplemental tax of 3.8% for all individual taxpayers earning $200,000.00 or more or couples earning $250,000.00.
SALE OF PERSONAL RESIDENCE
Effective May 7, 1997 the home sale rollover deferral rule of code section 1034 which provided homeowners of any age the opportunity to defer all or part of a gain by purchasing a replacement residence within two years before or after the sale has been replaced by a new "universal" exclusion. Additionally code section 121 which provided homeowners 55 or older the opportunity to exclude up to $125,000.00 of gain from gross income by making a special one time election was replaced.
UNIVERSAL EXCLUSION
The law provides that a seller of any age who has owned and used the home as a principle residence for at least two of the five years before the sale can exclude up to $250,000.00 from income if single (or married filing separately) and $500,000.00 for married joint filers.
TWO YEAR LIMIT
In general the exclusion can only be used once every two years, however, one's spouse's inability to use the exclusion because of the once every two years rule won't disqualify the other spouse from claiming the exclusion up to $250,000.00. For instance if Jane is single and sells her principle residence in January at $150,000.00 gain she can qualify for the home sale exclusion. If she marries John in April and moves in his principle residence which he has owned for ten years, he may sell the property in May and receive up to $250,000.00 tax free.
FORCED SALE RELIEF
If a taxpayer fails to meet the requirement that the property is used two out of the last five years or fails to meet the once every of two years rule due to a change of employment or health, they can be entitled to a pro-rata relief. For instance, Tom sells his principle residence after 12 months because of a new job in another city. He may exclude 12/24ths or $125,000.00 gain on the sale of his residence.
OTHER FORMS OF RELIEF
A surviving spouse of a deceased may "tack on" the decedents ownership period. Similarly, an individual who receives property incident to a divorce settlement can tack on the transferor's holding period to their own.
SERIAL HOME STRATEGY
Once you sell your personal residence with a zero tax bite you are free to move into any second home or income producing property you own and convert that property into your principle residence (for two years out of a five year period) to qualify for a tax free treatment up to applicable limits of $250,000.00 or $500,000.00. However if the property you are moving into was previously part of a 1031 exchange, the holding period for this benefit is five years.
RECAPTURE RULE
If the property you are relocating to was income-producing depreciation was taken, you are exposed to 25% tax liability on a portion of gain upon sale. For instance, if you bought a condominium for $175,000.00, made no improvements and deducted $15,000.00 in depreciation, your tax basis would be $160,000.00. Two years after converting it to your principle residence you sell the condominium for $325,000.00, representing a $165,000.00 gain given your $160,000.00 basis. Under the present law, capital gain is split in two parts: the gain attributed to depreciation previously pocketed, and the gain in resale value. The $15,000.00 depreciation is taxed at 25% ($3,750.00) and the rest of your gain of $150,000.00 qualifies as profit from the sale of a principle residence escaping taxation.