Your Guide to Primary Residence, Short-Term, and Long-Term Capital Gains
**Disclaimer: Though we work with clients and their accountants daily on real estate transactions and preferential tax treatment, we are not tax professionals, and this article is intended to be a general informational resource and foundation for discussion with your trusted tax professional.**
Capital gains taxes are owed on most assets and investments when you sell them for a profit, or “gain.” They apply to investments known as “capital assets,” which include stocks, bonds, and real estate. For the remainder of this article and for the purpose of focusing on our real estate clients’ needs, we’ll refer to assets requiring capital gains tax as real estate.
It might go without saying, but it is also important to understand the definition of the term “gain.” In shorthand, the taxable gain amount equals net proceeds minus cost basis. The cost basis is how much money has been put into the property (including major capital improvements), and the net proceeds is how much the seller takes home after all closing costs have been paid.
Capital gains taxes are not due until a property is sold, no matter how long it is owned or increases in value. There are currently three capital gains tax brackets (as compared to seven short-term federal income tax brackets): 0%, 15%, and 20%. The bracket you fall into depends on your filing status and your previous year’s income. Capital gains taxes should be a key element of your financial planning.
Primary Residence Capital Gains
Real estate capital gains are taxed under a different standard if you’re selling your primary residence. You will not owe capital gains tax if you have used a home as your primary residence for 2 of the last 5 years. These years do not need to be consecutive. If you are selling a second home or investment property, you will be responsible for full capital gains tax.
Short-Term Capital Gains
Short-term capital gains tax applies to assets held for a year or less and then sold for a gain. In this case, the gain is taxed as standard income under the federal income tax rates. For most taxpayers, this means a higher amount owed than under the capital gains rate. If you hold assets for more than a year before selling them, you will fall under the category of long-term capital gains, which, conversely, generally means your tax burden will be lower than that for short-term gains.
Long-Term Capital Gains
Long-term capital gains taxes are owed if you sell your property at a profit after owning it for more than one year. These are taxed at the capital gains rates of 0%, 15%, or 20%, rather than the standard federal income tax rates.
Planning for Capital Gains Taxes
The amount you’ll pay in capital gains taxes depends on deductions, your income, how long you’ve owned the property, and the amount you sell it for. There are a number of legal and tax strategies that can help minimize your capital gains taxes, and working with a financial expert or advisor is key.
It’s important to note that there are future planned increases to capital gains tax rates as well as possible revisions to the 1031 Tax Deferred Exchange under the Biden Administration, though they are still in the ongoing initiative phase. Due to these question marks on the horizon, we expect significant transactional volume to continue and increase through Q4 2021 to year-end. Many high net worth and high-income individuals and institutions are adjusting their portfolios to lock in historic (and likely lower) capital gains tax rates and execute the 1031 in its current state.
While no one has a crystal ball to know for sure how this will unfold, we’ll follow capital gains tax developments closely as 2021 comes to a close and into the years to come. This cornerstone quote by Zig Ziglar effectively sums up our attitude towards shifting investment landscapes:
“Expect the best. Plan for the worst. Capitalize on what comes.” -Zig Ziglar
There is always opportunity… Can we help you be the best possible steward of your estate? We are glad to connect to help investors and property owners alike to help plan for the best financial outcomes for their real estate decisions.
Altamont Property Group
828-782-5882, ext. 1