September '07

SOME VERY USEFUL INFORMATION

In this edition of the Real Estate Revolution, we will share some useful information that is to short to warrant a single newsletter.

CAPITAL GAINS RATES REVISITED

Exactly what Capital Gains rate applies to the sale of your property depends on several things, including when you bought the property, when you sold it, your overall income level and sometimes what tax-code changes are made in the meantime.

Currently, capital gains may be taxed at 5 percent, 15 percent and 25 percent or a combination of rates (These lower rates are scheduled to end on Dec. 31, 2010). These tax levels are known as long-term capital gains and apply to property that you hold for not less than 366 days (more than one year). The long-term capital gain tax is, generally, much lower than what you pay on your regular income.

In fact, it is a taxpayer's income level that generally determines which capital gains rate is owed. If your profit pushes you into a higher bracket, you could possibly be taxed at a combination of rates. And you could face yet another rate depending upon the type of property you sell.

Remember, each of the rates state here are the "long-term" capital gains rates. In most cases, that means you have to hold a property for more than a year before you sell it (366 days). If you cash it in sooner, you'll be taxed at the "short-term" rate, which is the same as your ordinary income tax level, which could be as high as 35 percent.

5-PERCENT RATE: This capital gains rate applies to taxpayers in the 10-percent income tax brackets. They will pay a maximum 5-percent long-term gains rate on property they held for more than 366 days.

15-PERCENT RATE: This most widely paid capital gains tax rate applies to long-term investments by individuals in the 25-percent or higher tax brackets. When you hear "lower capital gains rate," it generally means this level, because there are few investors with incomes low enough to qualify solely for the 5-percent rate.

25-PERCENT RATE (RECAPTURE OF DEPRECIATION): This rate applies to part of the gain from selling real estate that you have previously depreciated. Basically, this keeps you from getting a double tax break. The Internal Revenue Service will first recapture some of the tax breaks you've been getting via depreciation. You'll have to use Schedule D to figure your gain (and tax rate) for this property, known as Section 1250 property. More details on this type of holding and its taxation are available in chapter three of IRS Publication 544, Sales and other Dispositions of Property.

CAPITAL GAINS AND YOUR VACATION HOME

One mistake people make is thinking that because their vacation home is a residence, the capital-gains tax exclusion applies says lawyer William Abrams, a partner with Abrams Garfinkel Margolis Bergson LLP, a law firm in New York. "They say, 'It's a house. I am not going to have to pay capital gains tax on it when I sell it," says Mr. Abrams. That's not the case, he says. In actuality, the capital-gains tax exclusion ($250,00 non-taxable capital gain per spouse), generally applies only to principal residences, says Mr. Abrams, whose practice includes tax law. Vacation or second homes don't normally qualify.

UNDERSTANDING A HOMES ADJUSTED BASIS

What is known as a home's "adjusted basis" figures prominently into how a gain or loss is calculated after a residential property is sold. A home's "adjusted basis" is how much a homeowner originally paid for a house, including closing and settlement costs and debt (this doesn't include mortgages other than the original mortgage though), plus any qualifying home improvements made. These qualifying home improvements include ONLY items that increase the value of the property like a pool, another room, new roof etc.

For Uncle Sam, the gain or loss on your home sale is calculated by subtracting the adjusted basis from your selling price (less any related expenses (like qualifying home improvements) BUT not ANY of the debt other than the original mortgage). Therefore, the larger your adjusted basis, the less your gain may be (in the IRS's eyes), which may reduce your tax load.

IRS INSTALLMENT SALES

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you dispose of property in an installment sale, you report part of your gain when you receive each installment payment. NOTE: You cannot use the installment method to report a loss.

General Rules: If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method OR you are not a qualified "accrual" method taxpayer. Most people/entities use the "cash" method of accounting and not the "accrual" method of accounting.

References/Related Topics

Form 6252, Installment Sale Income (PDF)

Publication 537 Installment Sales