Understanding Capital Gain Tax On Real Estate

Capital gain tax is a type of tax you pay on your profitable investments. If you are into real estate investment or you want to sell your home, you need to understand what capital gain tax is and how it affects your profit.

What is Capital Gain Tax?

When you sell an investment for a price higher than the purchase price, you make what is called a capital gain. For instance, if you buy a real estate property for $50,000 and sell for $75,000 your capital gain is $25,000. Thus, the difference between your purchase price and the selling price is the capital gain. The selling price must be higher than the purchase price for there to be a capital gain. The capital gain tax is the tax you pay on your capital gain. From the example used earlier, you get to pay your capital gain tax from the $25,000 and not from the $75,000.

How to Calculate Capital Gain Tax on Real Estate:

You need to know the right way to calculate the capital gain tax. When calculating a capital gain tax, you have to add other incidental costs you accrued in the process of selling the asset. For instance, if you made some renovations and installations and evaluations on the asset before you sold, you include these costs in your expenses.

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A Practical Example on How to Calculate a Capital Gain Tax on Real Estate.

Let’s assume you bought a real estate investment for $50,000 last year. You spent $15,000 to renovate the property, and also you spent $1,000 on other minor fixings. You spent $3,000 to hire a real estate agent to help you find buyers for the apartment. Finally, you sold the apartment for $120,000. To calculate your capital gain tax, you add up all the costs you accrued to in the process of selling the apartment. From this instance, $50,000 + $15,000 + $1,000 + $3,000 = $69,000. Your capital gain will be $120,000 – $69,000 = $51,000. You pay tax on just the capital gain.

Capital Gain Tax for Home Owners:

If you want to sell your home, you may be worried about how the capital gain tax will affect your profits. The Capital gain tax for homeowners is entirely different, all thanks to the new Senate Tax Bill.  With the new tax bill, homeowners can enjoy some discount on their capital gain tax. With the new law, $250,000 is excluded for singles and $500,000 for couples. That means you won’t have to pay capital gain tax on the first $250,000 or $500,000 on your capital gain.

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Criteria to Qualify for IRS Capital Gain Exclusion:

To qualify for the capital gain tax exemption for homeowners, you must meet the criteria. The requirements for qualification include:

a. You must have owned the home for at least two years within the last five years before the time of selling the property.

b. The house must be your place of primary residence for at least two years within the previous five years before the time of selling the property.

c. You have not enjoyed exempted from capital gain tax from another home in the last two years.

Long-term and Short-term Capital Gain Tax:

Time matters when it comes to payment of capital gain tax. The length of time you hold on to a real estate investment is put into consideration when calculating the capital gain tax. A capital gain tax can be long-term or short-term. Long-term capital gain tax is paid on investments held for more than one year. Thus, to qualify for the long-term capital gain tax, you must hold the said investment for at least one year. Generally, you pay less on long-term investments. The rate % is usually 0% to 20% of the capital gain. Short-term capital gain tax applies for investments held for less than one year. Unlike long-term investments, you pay more on short-term investments. Also, for short-term investments, you are taxed on your taxable income. The tax percentage is from 10% and above for short-term capital gain tax.

Tips to Reduce Capital Gain Tax on Property:

From the explanations so far, you can see that capital gain tax cuts into your profits. Are there ways you can reduce the amount you pay on capital gain tax? Yes, there are some tips you can apply today to reduce the amount you pay on capital gain tax. These tips include:

a. Hold for a Long Period: Instead of flipping the property immediately, try to hold the property for at least for one year before you sell. With this, you pay long-term capital gain tax which is usually low.

b. Always Add Incidental Costs: Remember to all the additional cost you accrued in the process of selling the investment. That will help reduce the amount you pay on capital gain tax.