Thanks, Utah housing market, for a wild ride in the past two years. That’s the nature of the business and I couldn’t love it more. I don’t love the volatility, it’s not even the knowledge I have gained in the past three decades on the ground. I have watched market cycles for years and even I am impressed by its growth as of late. I love this industry because it affords me the opportunity to help clients make informed financial decisions.
A home sale or purchase could be one of the most important investments my clients will ever make. The market? She’s fickle. Real estate transactions can become complex. That’s why it’s time we had a serious chat about capital gains taxes.
A significant spike in Utah home prices beginning in early 2020 was a gift to existing homeowners. It seemed in the blink of an eye, many more than doubled their equity. Utah real estate sales are slowing but prices remain high compared to two years ago.
People who owned homes and property before the roller coaster began to climb, suddenly found themselves with some serious equity. Many cashed in. Soon, the tax bill will come due. If you were one of them (or even if you plan to be) I urge you to read up on capital gains taxes and then seek the advice of a tax professional. The Federal Reserve continues to increase mortgage rates. On Thursday (Oct. 27) it hit a 20-year-high of 7.08 percent. On Nov. 2, the Fed imposed a .75% increase.
The increases certainly put the breaks on home sales and purchases but it hasn’t come close to stopping them.
A real estate tax professional will help.
Congressional Research Service data shows that about two-thirds of federal individual capital gains subject to tax are from selling corporate stock. The rest is from property sales.
If you had capital gains in 2022, there are some basic points to remember in your financial planning (this information is specifically related to real estate):
- A capital gain or loss is the difference between the amount paid for a property and the amount for which it is sold. Yes, that’s a bit of an oversimplification but let’s stick with
that for now.
- Certain capital gains are exempt from taxation (but definitely not all).
- Length of ownership and occupancy are important considerations with capital gains taxes.
- The Internal Revenue Service will consider the dollar amount of a gain or loss, the use of a property in question, and allowed capital expenses.
- Unless you are a tax attorney, the money you spend for professional guidance could save you thousands. Now that is a real investment.
I’m not going to repeat the tax code to you here. I can’t possibly address every scenario; however, I did consult with my accountant Dave Lewis of Huber, Erickson & Bowman, LLC (HEB). Dave has a bachelor of science in accounting and a master’s of accounting (MAcc) from Brigham Young University. He specializes in providing audit, tax, and consulting services to homeowner associations, real estate, and construction clients throughout the western United
States. I became a certified public accountant during my service to the United States Marines.
Dave said there are some primary factors to consider when deciding whether or not you need to address capital gains taxes on the sale of your property.
How much was the gain?
The IRS built a safety net into the Section 121 exclusion in IRS Publication 523, Selling Your Home. If you are single, you could qualify for up to a $250,000 exclusion. A couple can exclude up to $500,000.
You sold your home. You bought it for $250,000 in 2018. You lived in it as your primary residence for two of the most recent five years (the time you lived there does not have to be contiguous). The market goes bonkers and you sell it in 2022 for $500,000. That’s a $250,000
It would be simple if that was the only factor you had to consider, wouldn’t it? It’s not. The IRS literally published a book on this.
Uncle Sam carefully considers these factors too:
- Ownership. If you owned the home for at least 24 months (two years) out of the last five years leading up to the date of sale (date of closing), you meet the ownership requirement.
- Residence. If you owned the home and used it as your primary residence for at least 24 months of the previous five years, you meet the residence requirement. The 24 months of residence can fall anywhere within the five-year period. The IRS mandates, “All that is required is a total of 24 months (730 days) of residence during the 5-year period. Unlike the ownership requirement, each spouse must meet the residence requirement individually for a married couple filing jointly to get the full exclusion.”
- Look-Back. As long as you did not sell a home (or if you did, you didn’t claim the exclusion) in the past two years, you meet the Look-Back requirement.
If you meet these requirements, you could qualify for a capital gains exception, it would definitely be worth pursuing with your trusted tax adviser. There are a host of exclusions and loopholes here that apply to divorce, death, marriage, invalid care, certain exchanges, and more so this so-called “Eligibility Test” is just the beginning.
The long and short of it matter.
The Eligibility Test we just reviewed is based on long-term capital gains. There is a different set of rules for short-term gains. I won’t go over them here, but be aware there is a difference. If you own the home you sell after owning it for a year or less, you will need to look into short-term gains and losses as they relate to taxes. If the asset is sold after more than a year, it is considered a long-term gain. Remember, the $250,000 to $500,000 exclusion applies to Utah just like it applies to the federal government.
Minimize your capital gains taxes.
Nothing tax-related is simple. There are some ways to minimize the taxable amount of your capital gain. It does require some advanced planning, and it does require awareness. That’s why you’re here, right?
Major, permanent improvements are spendy. Luckily, homeowners who make such improvements and keep good financial records (including receipts) can deduct them from the difference between the purchase and sale prices of their primary homes. IRS Publication 523 on Selling Your Home details some examples of improvements that might qualify. They include the following:
- Additions. Think bedroom, bathroom, deck, garage, porch, patio
- Lawn & Grounds. Major landscaping (mowing your lawn doesn’t count), a new driveway, a walkway, fence, retaining wall, or a swimming pool
- Systems. These can include a heating system, central air conditioning, furnace ductwork, a central humidifier, a central vacuum, an air/water filtration system, a security system, or a sprinkler system.
- Exterior. Some potential qualifiers are storm windows and doors, a new roof, siding, or
a satellite dish.
- Insulation. Energy conservation measures are often deductible including insulation in
your attic walls, floors, around pipes, and ductwork.
- Plumbing. Installation of a septic system, water heater, soft water system, and filtration
systems all qualify under plumbing.
- Interior. Built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting.
In general, small repairs and maintenance can not be excluded from capital gains unless they are part of a larger project. Whether you own a home now or plan to buy a home, these items can be great money-savers if you properly track them and keep careful records.
Timing is everything.
Refer back to the time guidelines and remember:
- You can only claim the capital gains exclusion on one property in a two-year period.
- You must have lived in the home as your primary residence for two of the last five years.
- You can claim an exclusion every two years as long as you lived in the property in question for at least two years.
- Short vacations don’t count against your time.
- If you spend time in a rehabilitation facility while the home is your primary residence, that doesn’t count against you.
A day really can make a difference when it comes to closing dates, so be prepared to plan accordingly.
Because the state and federal tax codes can be very detailed (and let’s be honest, confusing) the most sage advice I can give you is to consult an experienced tax professional before you buy your home, when you buy your home, and when you sell it to avoid unplanned tax ramifications.