With a new tax plan from the current White House administration becoming a distinct possibility, it leaves many Americans wondering about capital gains as it applies to real estate transactions. With the plan still in the discussion phase, there are few concrete details about what new capital gains rates could eventually be if it were to go through, but even the likelihood of the plan passing has many people asking what they can do to maximize their investments.
In terms of selling a personal residence or real estate that is held for investment or business use, it is crucial to look at what capital gains rates have been, and what they could be sometime soon.
Capital Gains Rates Now
Until the law concerning capital gains rates is changed, the rates are typically 15 to 20 percent depending upon whether an individual makes more than $250,000 or not. In addition to this, there is 3.8% that gets added to that investment income coming out of Obamacare for people who make more than $250,000.
The capital gains rate is 15% for people who:
- make $400,000 or less if they are single
- make $450,000 or less if they are married
And in addition, an individual making more than $250K a year has a 3.8% Obamacare net investment income tax added to that. Prior to this year, the maximum gain someone would be required to pay on a capital gains transaction is 23.8% which is essentially the 20% plus the 3.8%.
Capital Gains Rates and the Future
During the last year and a half and even prior to that, the government has spent a great deal of money due to COVID and other reasons. Because of this significant uptick in spending, it is not inconceivable that Americans will see a tax increase.
The new administration has already proposed an aggressive tax increase that would raise capital gains rates significantly, to as high as the mid-40s. While this is possible, some consider it even more likely that instead of the rates going from 23.8% to the 44%, the tax hike will instead put the maximum rate at 28%. This rate would only be reached with compromise.
America has had capital gains rates in the past of 28% so it is possible they will see them again if the tax plan passes. In light of this, it could be prudent for investors who are looking at potentially large capital gains transactions to anticipate a 28% rate in the near future.
Realistically, an individual who sells something now will continue to be at the lower tax rate, but if they decide to sell it toward the end of the year or after, it could very well be at a much higher rate.
The Potential Effect of Higher Capital Gains Rates on the Market
The fact that Americans are anticipating higher capital gains rates has had an effect on the market to a certain extent. Most people who are facing capital gains transactions have one of two reactions:
- “I need to do it now while the rates are lower.”
- “I’m not going to sell that stock or real estate ever because I’m not going to pay that kind of tax.”
The second reaction is particularly disheartening because this is not the desired effect. The goal is to still have individuals be able to sell their assets when they can and change their portfolio and doing so without having to play some sort of tax game with the respect to their business and investment decisions.
Personal Residences and Capital Gains Rates
A personal residence is only taxable to the extent that the gain on the house exceeds $250,000 for a single individual or $500,000 for a married couple.
For example, if a person and their spouse bought a house for $400,000 ten years ago and are now selling it for $800,000, it is simply a $400,000 gain.
However, a married couple who sells a house that exceeds the $250,000 or $500,000 limits may have to face new capital gains taxation on some of the proceeds of the sale of their house. Individuals who find themselves in this situation have either typically held on to their house for a long time, so it has greatly appreciated in value, or they own upper-end houses that have continued to go up in value since the time of purchase.
Tips for Capital Gains as It Applies to Real Estate Transactions
When it comes to capital gains as it applies to real estate transactions, there are a few tips that individuals may find helpful, such as:
- A person considering selling this year or next, may want to sell this year to take better advantage of a market that certainly seems to be hot right now.
- Individuals who do not typically have incomes that would kick in the higher capital gains rates may be wise to do something such as sell their house on an installment basis where they can recognize the gains spread out over several years because it looks as though the higher capital gains rates will only kick in at high income levels, like $1 million. However, if somebody doesn’t typically make that much money but has a one-time house transaction that’s going through soon, they may want to spread that out over more than one year via a seller note.
- For a business or investment property, an individual that wants to sell a portion of commercial or business use property may want to take care of that this year and recognize that income. If they want to avoid the income or spread it out, an installment sale could be a possibility.
- If an individual with commercial or investment property is wanting to sell a piece of their property and purchase another one, they may choose to defer some of the gain via a 1031 or a Like-Kind Exchange but should be aware there are many regulations and rules surrounding this process.
- A person buying property that costs as least as much as the one they are selling may be able to defer the whole gain. Or it might be possible to recognize some of the gains to stay under the threshold for higher capital gains rates.
- As part of the 2017 Tax Cuts and Jobs Act dealing with opportunity zones, some individuals may be able to invest to defer their capital gain until the year 2026. It must be an investment in certain geographically qualified areas.
The key to knowing about capital gains as it applies to real estate transactions is to try to figure out what your income is going to be, what impact the capital gain may have on it, and then plan ahead using some of the tips and strategies mentioned above. For more information, please contact our Real Estate Lawyer today.