Tuesday, February 25, 2014

Capital Gains and Capital Losses on Real Estate Sales

The Series 65 and Series 66 exams might ask a question or two about the tax implications of selling real estate, so let's look at some key issues here. First, if you sell your primary residence at a loss, you get no tax benefit whatsoever. Therefore, if your house is so underwater at this point that you will never sell it for a gain, you might consider turning it into a rental property and finding other digs. This way, you can take depreciation on the property, which will cancel out some or all of the rent you receive for tax purposes. And, when you sell at a loss, you can use that to offset taxable income. I'm not saying that would be cause for a case of Dom Perignon, but it might turn a bad situation into something a little more beneficial.
On the other hand, if you have a house that will sell for a capital gain, you might be able to avoid paying any tax on it at all. But, you have to be able to go back 5 years from the date of sale and show that you both owned the house for any 2 years during that period and used the house for any 2 years during that period. These 2-year periods do not have to be continuous and they do not have to happen at the same time. For example, I'm sitting on a house with some real equity at the moment. While I have used the house for two years at this point, starting as a renter, I have only owned it since last November 1st. Therefore, to turn any capital gain into a tax-free gain, I need to own the place for another 21 months. That means I can either live here for 21 months, or rent the place out for some or all of that time.
Either way, if I sell a year from this coming November and realize, say, a $75,000 capital gain it will all be tax-free. If I didn't establish the two-year ownership period going forward and sold for a $75,000 capital gain, on the other hand, the IRS would tax it at either 15% or 20%, meaning I would keep only $63,750 if taxed at 15% or just $60,000 if taxed at 20%.
There are ways around having to both own and use a residence for 2 of the previous 5 years and still get the tax-free capital gain, but I don't qualify for any of them. If interested, check out www.irs.gov "selling your house". pass your series 65 NOW!

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