Many Home Sellers Aren’t Familiar With the Capital Gains Tax Exemption

I’m not an accountant or tax advisor, but periodically I need to explain to clients the exemption on capital gains tax enjoyed by homeowners. (You’ll want to verify what I write with your accountant or tax advisor.)

Prior to 1997, the seller of one’s primary residence was required to buy another home that was at least as costly as their previous home in order to avoid paying capital gains tax on the sale.  Since passage of the Taxpayer Relief Act of 1997, however, that is no longer the case, although there are several important rules.

First of all, the home you sell must have been your primary residence for two of the five years preceding the date of sale, and you can only do this once every two years. 

Rita and I once sold a home after owning and living in it for just 18 months, but there was no gain on the sale, so it didn’t matter that we didn’t qualify for the exemption.

Occupancy does not have to be continuous. You only have to have lived in the house for a total of 24 months prior to the date of sale. If you want to enjoy the exemption on a home that you previously lived in, then rented for less than five years, you may need to move into it until the total occupancy meets the 2-year requirement, if you want to enjoy the exemption.

If you’re single, you are exempt from tax on the first $250,000 of gain. For a married couple, the exemption is doubled. (For LGBT couples who own a home together, being able to marry legally brought with it this significant financial advantage.) The gain is calculated by deducting from the sale price your “basis” in the home.  That basis is the sum of the price you paid for the home, the cost of improvements or additions made to it, and the costs and fees associated with purchasing and selling it. Those fees include real estate commissions, title insurance, recording fees, legal expenses, etc.

For example, let’s say you bought a home 30 years ago for $100,000 and you sell it for $700,000 this year. You are married, so you qualify for the $500,000 exemption. If you can document $50,000 in improvements (not repairs), and your cost of selling was, say, 6%, including commissions, title insurance and fees, your basis is increased by $92,000, raising it to $192,000. Thus, your gain was $508,000, but only $8,000 of it is taxable. You will owe 15% federal plus 4.5% Colorado capital gains tax on that $8,000. That amounts to $1,560 tax that would be due the following April 15. That still leaves a lot of tax-free profit from the sale!

Now and then, I meet a couple, like I did last week, who are selling a home they purchased over 30 years ago, and are pushing up against a capital gains tax liability, especially if the homeowner is not married. (If the homeowner is widowed, he or she has two years to sell before the exemption drops to $250,000.) If you are in that situation or approaching it, you could benefit from selling your home and buying another one.

It’s a mistake to put your heirs on the title of your home so they inherit it. That’s because in addition to inheriting your home, they also inherit your basis, which could cost them dearly when they end up selling it.  It’s better to put them on a “beneficiary deed” or let them inherit it through your will. In either scenario, the basis of the home is stepped up to its market value at the time of your death.  The beneficiary deed is a particularly attractive option because the cost of creating and recording it is minimal, and it can be revoked at any time.

One of my clients is a home builder. He builds homes one at a time over a 2-year period, moving into and living in each of them for two years while building the next house. That way he is able to apply the full $500,000 marital exemption to the sale of each house, whereas he’d owe regular income tax on his profit for each home if he sold it upon completion.

You can claim the exemption on the sale of a second home, but you need to have lived in it as your primary residence for two of five years preceding the date of sale, and, as mentioned above, you have to wait two years before taking that exemption on your other home.

If you have additional questions about qualifying for this tax exemption, don’t ask me. As I said, I’m not an accountant or tax advisor.  However, I can refer you to our accountant (who does our taxes) if you don’t have one. I can also refer you to a real estate lawyer for a beneficiary deed.

You Can Defer Capital Gains Tax on the Sale of Investment Properties — Or Reduce It

Colorado owners of investment real estate have built up a lot of equity over the last several years through appreciation. Selling those properties outright would subject the seller to significant capital gains tax, but there are several strategies for deferring — and in one strategy reducing — that capital gains tax liability.

Many property owners have inquired about selling their investment property in a way that locks in their gains — including owners who are looking to exit the landlord business altogether. 

Whether your rental property is a single-family home, a duplex, other multi-family dwelling, or a commercial property, you may well be looking to cash out while values are high, but how do you do so while minimizing your tax exposure?  There are several strategies for doing so, but one that was created by the Tax Cuts and Jobs Act of December 2017 is particularly attractive, both for its flexibility and the fact that it allows for reduction of the deferred capital gains tax and elimination of future tax.

There are four exit strategies that simply defer capital gains tax obligations. They include the traditional Installment Sale, the Monetized Installment Sale, the Deferred Sales Trust and the Delaware Statutory Trust. By using one of these exit strategies, you can defer the amount of tax you pay on the sale of a rental property, putting your pre-tax capital to work elsewhere. A fifth tool, the Opportunity Trust Fund, created by the Trump tax bill, is likely to become every investor’s favorite. Let me explain why.

The Trump tax bill allowed states to identify “Opportunity Zones,” and Colorado identified 126 such zones, 40% of which are in the Front Range, including Denver and Jefferson County. Altogether there are now 8,700 Opportunity Zones in all 50 states, the District of Columbia, and in five U.S. territories.

If a new investment in an Opportunity Zone property — or in an Opportunity Zone Fund which invests in such properties for you — is held for 10 years, you pay no capital gains tax when you sell.

There’s a further advantage when you roll the capital gain on your current investment property into an Opportunity Zone investment, because you can sell your current property, take out your basis on that property tax-free, while rolling only your gain into an Opportunity Zone Fund. Your basis on the rolled-over gain is increased (and tax liability reduced) by 15% after 7 years, and your gain on the new investment is tax-free if you hold it for 10 years. I’m told that these tax benefits decline on investments made after 2019.

In this article, I’m only telling you what I understand from reading up on the subject, including at https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questionso. You’ll want to speak to your tax advisor before making any changes in your real estate investment portfolio.

I thank broker associate Andrew Lesko, who specializes in duplex and multi-family properties, for bringing this and the other tax-saving strategies to my attention. If you’re thinking about selling your duplex, triplex, townhome or condo, contact Andrew for a current market analysis at 720-710-1000 or visit www.DuplexAlerts.com, where you’ll find more details about all five tax deferral/reduction/elimination strategies.

If you have a commercial property to sell, call me at 303-525-1851 so I can refer you to a trusted commercial broker.

Have You Owned Your Home a Long Time? Here Are Some Tips for Avoiding Capital Gains Tax

If you bought your primary residence back in the 1960s or 1970s, there’s a good chance that you’ll be pushing the limits of the capital gains tax exemption when it comes time to sell.

There is an exemption of capital gains tax of $250,000 (single) or $500,000 (married) for a home that was your principal residence for at least two of the five years preceding the sale. If you bought your house for, say, $30,000, in the 1960s, it’s quite possible that it’s worth 10 or 20 times that amount now, resulting in the possibility of capital gains taxation.

If one of a married couple moves out, the $500,000 exemption is preserved by the other spouse as long as the absent spouse is still alive, providing the couple sells the house within 3 years of both moving out.

Do not add your heirs to the title of your home as a “joint tenant” with right of survivorship.  That’s because your heirs inherit your original purchase price as their cost basis, whereas if they inherit the property through your will, the basis for them is stepped up to the fair market value of the home at the time of the inheritance, which will help them avoid capital gains tax when they sell it.

I am not a tax advisor, and am only recounting what I have been told by tax and estate-planning professionals. Consult your own tax professional before acting on anything I have written here.

Ways to Defer Capital Gains Tax Exposure When Selling Investment Properties

With the new year upon us, many of us are thinking about taxes. While it’s too late to strategize for 2018, let’s look at tax strategies going forward.

Owners of duplex, triplex and small multi-unit properties sell their properties for many reasons. Sometimes an owner wants to leverage equity into another property with better upside potential or a higher return on their investment or into multiple income producing properties.

Perhaps a duplex property was inherited but the responsibility of being a landlord has become overly burdensome. Whatever the situation, there are times when selling a multi-unit rental property and transferring the equity into an alternative “hands-off” type of investment makes sense. You can defer your capital gains tax obligations and keep your pre-tax capital growing for you by utilizing one of these IRS-approved options.

1031 Real Estate Exchange: The 1031 real estate exchange is a tax-deferral strategy that applies to investors who have sold or are about to sell investment real estate. This strategy allows a client to defer capital gains tax on all sales proceeds that are reinvested into other investment real estate properties, as long as the seller:

1) does not take “constructive receipt” of the funds within the exchange transaction.  This means that the proceeds must go directly to a “qualified intermediary” and not at any point be in the seller’s own bank account.

2) meets all requirements outlined in the Internal Revenue Code.

721 Exchange: Less well-known than the 1031 exchange, the 721 exchange is another tax-deferral strategy which applies to investors who have sold or are about to sell investment real estate. This strategy is similar to the 1031 exchange but allows an investor to exchange his property for an interest in a diversified real estate portfolio known as a Real Estate Investment Trust (REIT). As with the 1031 exchange, the seller must not take constructive receipt of the sales proceeds within the transaction.

Delaware Statutory Trust is offered as replacement property for those seeking to defer capital gains taxes via a 1031 exchange. The DST allows for fractional interest ownership in various managed commercial properties with other investors, as individual owners within a Trust. Each owner receives a share of the cash flow income, tax benefits, and appreciation of an entire property. There is potential for annual appreciation and depreciation. Investments begin at $100,000 and allow investors to diversify into several properties.

Deferred Sales Trust is a tax-deferral strategy that applies to many different capital gains situations. These include the sale of a business, real estate, stocks, or bonds, as well as the maturity of principal on a note or carry-back, and even applies in certain debt forgiveness situations. The Deferred Sales Trust is different from the 1031 and 721 exchanges in that it does not require any reinvestment of the sales proceeds into real estate. It is similar to 1031 and 721 exchanges insofar as an investor cannot take constructive receipt of the funds within the transaction.

For expanded, detailed information on each of these tax strategies, visit www.DuplexAlerts.com and click on the  “Sellers” tab in the main menu.

Always consult with your tax or wealth management professional when considering the sale or purchase of an investment property.

A quick caveat:  Neither I nor any agent at Golden Real Estate is a CPA or tax advisor.  Broker associate Andrew Lesko did the research for this article.  Email Andrew at Andrew@GoldenRealEstate.com or 720-710-1000 with your questions or comments.