How Does the Capital Gains Tax Work?
HOW DO YOU CALCULATE CAPITAL GAIN?
The capital gains tax is a tax you pay on the profit from the sale of any capital asset, including real estate. To understand the capital gains tax, we must first understand “basis.” Basis is the cost of buying, building, or improving a property. For example, if you paid $500,000 for a property, and spent $100,000 in improvements over time, your basis would be $600,000. If you sell the property for $1 million and pay $80,000 in closing costs, your profit on the sale would be $320,000. You would then need to pay capital gains taxes on that profit.
WHAT IS THE CAPITAL GAINS TAX RATE?
The Federal capital gains tax rate is currently 15% for most taxpayers. It's 0% if you're in the lowest income tax bracket and 20% if you're in the highest income tax bracket. So, in the example above, you'd need to pay $64,000 in taxes if your capital gains tax rate is 20% or $48,000 if your capital gains tax rate is 15%. You may also have to pay a state tax and a 3.8% federal "net investment income tax." This means your tax rate on capital gains could be up 23.8% on a federal level, plus your state tax rate. Please see a CPA for details on your specific situation.
IS THERE ANY WAY TO AVOID OR DEFER PAYING THE TAX?
Possibly. If the property is your primary residence, and you've lived there for 2 out of the past 5 years, you may be able to exclude some or all of the capital gain from taxes. That's one reason why you may want to consider selling your property now before it goes up in value any further. Please see my article on the primary residence exclusion for more details. If the property is an investment property, you may be able to defer the tax by using a 1031 Exchange. See my article on 1031 Exchanges for more details.
PLEASE NOTE: THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 523 FOR PRIMARY RESIDENCES OR IRS PUBLICATION 544 FOR INVESTMENT PROPERTIES.
It's a tax that you pay on the profit from the sale of any capital asset, including real estate.
Source: Momentifi