2020 has been a paramount year for the home sales market. Did you sell a property and wonder if your sales transaction will be taxable?
Your Primary Home
Generally, the sale of your primary home is not a taxable event. We say generally because this is true as long as it has been your primary residence for two of the last five years. If this is the case, and you are a single taxpayer, you can avoid paying tax on the first $250,000 of gain ($500,000 if you are filing a married filing joint return).
Rental property sales are taxable at capital gains rates. The calculation of how much tax is due depends on many factors. First, the initial cost basis of the property will need to be known. This is what you paid for the property, minus the value of the land. You are able to add closing costs into the basis to increase it. Each year, you will take a depreciation deduction based on the character of the property (residential versus commercial). If you made improvements to the property, they are also depreciated on potentially their own schedule. Once you sell the property, the sales price, minus any closing costs and realtor commissions, will reduce the amount that the gain is factored against. This is a very elementary view on how the taxation of your rental property is calculated, so as you may be able to tell, having an experienced tax consultant can alleviate the burden of properly calculating the amount subject to capital gains.
When a property is purchased with the intention of resale (often referred to as “flipping”), the gain likely will be taxed as ordinary income. If a person partakes in the business of flipping houses, they are considered a “dealer”, not an investor. A dealer is a person who buys the property with the sole intention of reselling it, not renting it or holding it for a period of time. Profit received by house flippers, (minus any costs for improvements, closing costs and commissions) will almost certainly be taxed as ordinary income. The IRS has a high level of scrutiny on house flipping profits and will consider a person a dealer of homes if they flip them, even if house flipping is not their primary means of income.
If you inherit property, the property will receive a step up in basis on the date of death of the owner. This can be especially beneficial on property that has been held for a long period of time. Inherited property that was someone’s primary home can generally avoid any gain. Since the property is inherited, you will not receive the $250,000 home sale exclusion because you will not meet the use and timing test. However, when you sell the property, you will more than likely have little to no gain due to the holding period. In this real estate market, there have been a lot of homes selling for higher than asking, so if there would happen to be a property that sells for more than the asking price, there may be a component of gain on the sale.
If you have any taxation questions related to the sale of real estate, please contact us. We would be happy to discuss your personal situation and assist you with preparing your taxes and planning for the future.