February 1, 2017
There are two main taxes to consider when discussing real estate in the U.S.: real property tax and capital gains tax. The market value of a property at the time of purchase determines the real property tax, while the capital gains taxes are assessed based on the net profit at the time of the sale.
The amount of tax levied on a property is usually determined by the length of time it is held. According to Edward J. Hannon, a partner at Quarles & Brady law firm in Chicago, “In general terms, property held for investment less than 12 months will be taxed as a ‘short-term’ capital gain.” He also points out that, “The rate on short-term capital gain is the same rate that applies to ordinary income (i.e. regular tax rates).”
- Michael Soroy, principal at Law Offices of H. Michael Soroy, in Los Angeles explains that in addition to the federal capital gains tax on real property sales, 41 states levy their own capital gains tax, at a typical rate of “3% to 8% on the net gain.”
Properties held for more than 12 months before reselling are taxed at the “long-term” capital gains rates typically lower than the short-term rate. A taxpayer in the top marginal rate will be subject to federal income tax at the 39.6% rate on short-term capital gains, but the rate applicable to long-term capital gains would be only 20%,” Mr. Soroy clarifies.
In some instances, holding a property for longer than 12 months is a way to save money, while in other cases, it is financially better to sell a property quickly. According to Mr. Soroy, there are at least three instances when a quick sell is the better choice:
- The seller is a foreign national and neither a U.S. resident nor a U.S. citizen
While any state capital gains tax still applies, “the federal capital gains tax rate is a flat 30% for nonresident aliens and does not take into account long-term versus short-term or individual tax brackets. Thus, a nonresident alien’s (foreign national’s) decision to sell or not within a year should not be solely governed by the federal capital gains tax rate.”
- The seller is a U.S. resident in a lower-income tax bracket resulting in lower capital gain taxes
“If the flipper resides in the U.S., the difference can be as high as 20% between long-term and short-term–typically around 10% to 15% depending on the flipper’s income tax bracket.”
- A shift in the market seems imminent and could result in like-kind exchanges
If the seller notes “plausible signs that the market is about to peak or flatten,” it would be better to “take a hit on the capital gains tax rate in a depreciating market instead of a loss after the 12-month period.” Mr. Hannon agrees, noting “In certain circumstances, a taxpayer can engage in a like-kind exchange which, in effect, allows a property owner to sell one property tax-free if the taxpayer acquires a replacement property and meets the many conditions set forth in Section 1031 of the Internal Revenue Code.” Keep in mind, “there is no minimum holding period to be eligible for like-kind exchange treatment. However, the taxpayer must be able to establish that the relinquished property was held for investment.”
Source: Mansion Global