Capital gains. I want to cover this a little bit, share a couple key points that will help you on this front. I’m not a tax person, but as a real estate agent I get asked about it all the time so I figured it was time to address the topic. Plus it goes along with this whole series I’m doing on getting your real estate deals done now, vs later.
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The thing you need to know about capital gains is that, although it does eat up a portion of your profits (or gains as they’re referred to), that is the only part of the proceeds that is in consideration. What that means is, you are only going to owe a percentage of the gains you will have on a sale. So to reiterate further, if you buy a house for $200,000 and then you turn around and sell it for $300,000, you’ll owe some taxes on the $100,000 profit from the sale. Now, say you do $40,000 in updates and improvements to make that profit. Those are deductible expenses to a point, so that could shrink your profits to $60,000, which also reduces how much you’ll pay in capital gains.
That’s important to know, and is the most confused point about capital gains that I see. Most people think they’re gonna have to pay more than 20% of the entire sale back to the IRS, but that’s just not true.
Another thing to bear in mind is that the capital gains tax rate is based on your personal income. It works just like income tax rates. They are broken into brackets or tiers, and change as income changes per person, or people filing jointly. The tax rate on net capital gains is no higher than 15% for most individuals. This year if you make less than $40,000 you may not have to pay a capital gains tax at all, and that also goes for couples making less than $80k filing jointly.
To properly figure out how much you could owe in capital gains taxes, you really need to get online and search for publications on the IRS website – I’ll put a couple links in the description for this video. But, suffice to say, if you haven’t dealt with many sales of real property, then you may not have come across this particular tax, or maybe it’s just been a while. The shorter time you lived there, the more you will pay because the short-term capital gains tax is higher than the long term rate. But that’s another good thing to know, if you’ve lived in the house for 2 years in the last 5 years before the sale, you won’t owe capital gains taxes. Other things that help you avoid the tax altogether fall in a category of “unforeseeable events”. Those are unique circumstances.
But if you owe them, you can offset capital gains in a few ways. One way to offset your gains is by making improvements, as I mentioned before. Those are considered losses, or expenses that count against value and profits on a sale. Another way is to defer your tax burden by doing what’s called a 1031 exchange. This is where you basically sell one piece of property to purchase a similar piece of property, something of comparable value. Now 1031 exchanges are a beast, every exchange is different so it’s hard to really dig into what that can look like. For our purposes right now, just know that this is a way defer the tax burden of a sale, because you’re flipping your investment from one property to another.
Now this is a heady topic, so I’m not gonna dig any deeper. I know this is just scratching the surface, but hopefully it gets you started on a better understanding of what capital gains is and how it works. You now know some key points to help you reduce or avoid them altogether. If you need more help or clarification let’s talk about your unique situation, give me a call, I’ll be around.
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