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Real estate and capital gains: 3 things to know

On Behalf of | Jan 18, 2023 | Real Estate Transactions |

Property owners who sell real estate at a profit may need to pay capital gains taxes. The reasoning is basically that the Internal Revenue Service (IRS) views the gain in value as a form of taxable income.

The IRS generally applies a capital gains tax to the value of the property, referred to as its tax basis, taken from the agreed upon sale price. Tax law recognizes that improvements to the property will impact the tax basis. As a result, it is important to keep track of improvements made to the real estate. This includes everything from a new roof to an updated kitchen. This can add value to the tax basis, increasing the price the IRS recognizes as the value of the home and thus lowering your tax obligation when it comes to any applicable capital gains tax.

Three other factors that can impact capital gains for real estate transactions include:

1) Type of property

Whether the IRS deems the property as issue a primary residence or investment property will impact the tax. Although tax savings are present for investment properties, the savings are not as big when compared to those available for a primary residence. As a result, the IRS is particular in its distinction between a primary property and investment property.

2) Marital status matters

Property owners can generally exclude $250,000 in taxable gain on the sale of their primary residence if single. This number increases to $500,000 if married.

3) These numbers can change

Home values and tax rates are not static. These are two variables that directly impact the capital gains tax. Take a moment to calculate the estimated tax and take the potential for change into consideration when evaluating whether to move forwarding with the sale.

It is also important to note that the Internal Revenue Code (IRC) has a provision that allows you to delay paying capital gains taxes on certain real estate transactions. This provision, Section 1031 also known as a like-kind exchange, can mean big savings when selling property. The provision is complex, and the IRS expects taxpayers to follow the rules in order to qualify for tax savings. Those looking to move forward with 1031 like-kind exchange can benefit from having real estate transaction documents drafted specifically to their transaction.