As of July 2023, the National Association of Realtors reports a 1.9% increase in the median price of existing homes sold compared to the same period in 2022. If you’re contemplating selling your home, which could very well be your most significant asset, to capitalize on this upward trend in home values, there are several crucial factors you should consider.
Understanding the Tax Implications
Determining “Gain”: Before diving into the tax rules, it’s vital to understand how to calculate your “gain” when selling your property. The gain is essentially the difference between what you paid for your home and the selling price, adjusted for certain expenses and improvements made to the property during your ownership.
State Taxes: One critical aspect often overlooked is state taxes, which can have a significant impact on your home sale profits. For instance, in states like California, the gain from selling your home may be subject to ordinary income tax rates, potentially resulting in a substantial tax liability.
Tax Rules for Primary Residences
If your property serves as your primary residence, you have the opportunity to exclude a portion of your gain from federal taxes. You can exclude up to $250,000 of gain if you’re filing as a single taxpayer, or up to $500,000 if you’re filing jointly with your spouse.
To qualify for this exclusion, you must have owned the property for at least two years during the five-year period leading up to the sale, and it should have been your primary residence for at least two of those years.
Remember that this exclusion can typically be used only once every two years.
Gains above the exclusion limit are likely to be taxed at your long-term capital gains rate if you’ve owned the home for at least one year. Otherwise, it’s considered short-term and subject to your regular income tax rate.
Furthermore, it’s important to note that if you sell your primary residence and qualify for the exclusion, the excluded gain is not subject to the 3.8% Net Investment Income Tax (NIIT). However, any gain exceeding the exclusion limit may be subject to the NIIT if your modified adjusted gross income surpasses certain thresholds.
Second / Vacation Residences
Vacation homes do not qualify for the gain exclusion mentioned above. However, when dealing with rental properties, things become more complex. Rental properties may be considered business assets, potentially allowing you to defer taxes on any gains through strategies such as an installment sale or a Section 1031 exchange.
Additionally, you might be able to deduct losses from your rental properties, a benefit not applicable to your primary residence.
Illustrating the Complexity with a Story
To make these intricate tax rules more relatable, consider a hypothetical scenario.
Imagine Jane, a homeowner in California, decides to sell her home after residing in it for several years. She’s thrilled about the potential profit from the sale, but her excitement is tempered by the realization that her gain might be subject to ordinary income tax rates due to her state’s tax laws. Jane navigates this complex terrain by seeking advice from her ZRC wealth advisor, who helps her understand her options and develop a tax-efficient strategy.
Take Action Today
These tax rules can significantly impact the outcome of your real estate investments. To ensure you make informed decisions and maximize your returns, it’s essential to consult with a knowledgeable financial advisor. Reach out to your ZRC wealth advisor today for personalized guidance tailored to your unique situation. Don’t let tax complexities hinder your financial success. Schedule a meeting with Barry, Kevin or Ryan to learn more!